Shares of Chinese technology giant Tencent (OTCMKTS:TCEHY) were on a tear in 2019. Until they weren’t. Through the first four months of the year, TCEHY stock rose 25% amid easing global trade tensions, improving economic conditions in China, and improving fundamentals for Tencent stock.
But, in May, TCEHY stock dropped 15% as global trade tensions escalated, and threatened those improvements in China’s economy and the Tencent narrative.
To be sure, the trade war is a big scary thing with a lot of unknowns. No one knows how long it will drag on for. No one knows exactly what it will entail, how big the impact will be or what a resolution will look like. Because of all those unknowns, a lack of growth clarity could weigh on Tencent stock for the foreseeable future.
But, in the big picture, Tencent is a secular-growth company at the epicenter of China’s secular-growth digital economy. Both those growth narratives were hit off course in 2018 by certain one-off headwinds. Those headwinds are now in the rearview mirror. As such, both growth narratives are back on track in early 2019. The trade war could knock them off course again. But, if it does, the hit will only be temporary, because this trade war likely won’t last.
Consequently, Tencent stock is presently characterized by potential near-term risk and guaranteed long-term reward. That creates a favorable setup for long-term investors to take advantage of recent trade-related weakness in the stock.
Tencent Is A Secular Growth Company
In the big picture, Tencent’s core internet economy growth narrative was hit off course in 2018. But, it is now back on track in 2019. This narrative should remain on track for the next several years. As it does, it should power TCEHY stock meaningfully higher.
Tencent is at the epicenter of China’s digital economy. The company is somewhat like the Facebook (NASDAQ:FB), Netflix (NASDAQ:NFLX), PayPal (NASDAQ:PYPL), Electronic Arts (NASDAQ:EA) and Microsoft (NASDAQ:MSFT) of China, all rolled into one. They operate the country’s largest social media apps, largest streaming platforms, largest digital payments platforms, and largest gaming marketplaces. They also operate one of the country’s biggest cloud businesses.
All in all, then, wherever the digital economy spans in China, Tencent is there, too, and with a huge presence.
China’s digital economy is a secular growth narrative. China’s middle class is rapidly expanding and urbanizing, creating a surge of participants in the country’s digital economy. Internet penetration rates across the country remain below developed country averages, as does consumption and income per capita. All three of those rates will rise over the course of the next several years. As they do, China’s digital economy will expand rapidly as will Tencent’s various businesses.
Tencent has been a 30%-plus revenue grower over the past several years with falling margins. Over the next several years, revenue growth will slow as China’s digital economic expansion slows. But, margins should moderate as management focuses less on growing into new markets, and more on profitably scaling current operations. Consequently, I see this company as a 20%-plus revenue and profit growth company over the next several years.
Ultimately, that level of sustained profit growth should drive TCEHY stock higher in the long run.
Near-Term Tailwinds Outweigh Headwinds
In the near term, Tencent stock is characterized by a few tailwinds, and a few headwinds. But the tailwinds should offset the headwinds, and the stock should rebound from its May selloff.
On the tailwind side, Tencent is benefiting from three things. One, China’s economy has stabilized and shown signs of improving in 2019. This is largely due to what was improving global trade relations. Two, the China video game market freeze which killed Tencent’s gaming business in 2018 is now in the rearview mirror, because China regulators are now approving games again. Three, margins are finally starting to show signs of stabilization after several years of big compression, mostly due to the nascent payments and cloud businesses finally maturing.
On the headwind side, you have the trade war. Ultimately, the trade war could negate the first tailwind for Tencent stock.
But what about the other two tailwinds? After all, even amid loud trade war noise and a video game freeze in 2018, Tencent still reported revenue growth rates consistently north of 20%. Even if that trade war noise gets louder, the lack of the video game freeze headwind should enable the company to keep growing at a 20%-plus rate.
Importantly, margins are finally stabilizing after huge compression in 2018. If this stabilization persists, that 20%-plus revenue growth should flow into 20%-plus profit growth, versus what was essentially flat profit growth in the back half of 2018. Ultimately, this return to profit growth in 2019 should push Tencent stock higher, regardless of trade war noise.
Bottom Line on TCEHY Stock
Long term, Tencent stock is a winner. Short term, Tencent stock is a mixed bag of tailwinds and headwinds. But the short-term tailwinds are broader and more relevant than the short-term headwinds. As such, near term strength should offset near term weakness, and TCEHY stock should bounce back from its May selloff.
As of this writing, Luke Lango was long TCEHY, FB, NFLX, and PYPL.