Chinese stocks have had a tough time over the past couple of years. From tech regulatory crackdowns to billion-dollar antitrust lawsuits and threats of being delisted from U.S. exchanges, multiple factors have caused Chinese stock prices to be decimated. However, there have been signs of the tide turning as the regulatory crackdown draws to a close and regulators in the U.S. and China work to reach an understanding.
According to a Bloomberg survey of 19 fund managers and analysts, 70% plan to maintain or boost their holdings in Chinese stocks. They also predict benchmark stock indexes in China and Hong Kong to outperform the global market and post gains of at least 4% by the end of 2022. This is a positive sign and comes off the back of Beijing planning to ease the tech crackdown moving forward. The story isn’t over yet, and a policy U-turn isn’t expected, but things are looking up.
Thus, let's take a look at two of my favorite Chinese stocks that I believe are undervalued at present.
1. Alibaba
Alibaba (BABA, Financial) is sometimes referred to as the “Amazon (AMZN, Financial) of China." It is a market leader in both cloud computing and B2B e-commerce. The company has been at the heart of the Chinese tech crackdown and was even slapped with a $2.8 billion fine in 2021 (which was honestly much lower than expected and gave investors hope for an easy resolution).
However, now pressure is easing and investor sentiment is becoming more positive. Alibaba’s stock price has even rallied by 37% since the lows of $86 per share in April.
Alibaba produced strong earnings during its latest quarter ended in March. Revenue for the quarter was $32 billion, up 9% year over year and above analyst estimates of $29.9 billion. Revenue growth was driven by a strong local consumer services segment, which increased by 29% year over year to $1.6 billion. The second fastest growing segment was Alibaba cloud, which expanded by 12% year over year to $2.9 billion. The largest segment, commerce, also did well, up 8% year over year to $22 billion.
Adjusted earnings per share was $1.55, up 44% and beating analyst expectations of $1.07. Alibaba's annual active consumers increased by 28.3 million to 1.3 billion people.
Alibaba had good results overall, but it did produce a major GAAP net loss of $2.5 billion. This was partially due to decreases in the share prices of equity market investments. Free cash flow also posted a loss of $2.3 billion, which was larger than the equivalent quarter in 2021. The company was also paying the final installment of $1.4 billon for its $2.8 billion fine from the anti-monopoly case.
Management was bullish on future prospects and increased its buyback program to $25 billion from $15 billion.
In terms of valuation, Alibaba trades at an enterprise-value-to-Ebitda ratio of 14.95, which is cheaper than historic levels.
In addition, the GF Value line indicates a fair value of $369 per share, making the stock significantly undervalued.
2. Tencent
Tencent (TCHEY) is the mammoth sized technology holding company. The company has dominated the social media and gaming landscape in China for many decades. However, the company faces intense scrutiny from Chinese regulators over alleged money laundering via its WeChat Pay App. Regulators had concerns that the platform was used to transfer funds for gambling, which is banned in mainland China. The company is expected to receive at least a $1.5 billion fine, which is substantial, but not really for a company of its size.
Tencent stock is down 56% from its highs in February 2021. Prosus NV (AMX:PRS) , a tech holding company and early stage investor into Tencent, has a 28.9% stake in the company. However, recently management have been selling shares in order to fund buybacks in itself. This was mainly to “close the gap” in value for itself, so I do not believe this to be a sign that they have lost faith in Tencent. Prosus CEO Bob Van Dijk stated, “It’s a big bazooka idea to address a market inefficiency but that also retains our exposure to (Tencent), one of the best companies on the globe”.
Tencent announced stable earnings for the first quarter of 2022. Total revenue was $21 billion, which was flat year over year.
Under IFRS reporting, operating profit decreased by a substantial 34% year over year and the operating margin decreased to 27% from 42%. Profit for the quarter decreased by 52% to $3.7 billion and the the net margin also decreased substantially to 18% from 36% in the prior year.
This decline can be mainly attributed to a large increase in operating expenses, such as $1.2 billion in selling, general and administrative expenses. According to the CEO of Tencent Pony Ma:
"During the challenging first quarter of 2022, we implemented cost control initiatives and rationalised certain non-core businesses, which would enable us to achieve a more optimised cost structure going forward.”
All eyes will be on Tencent ‘s second-quarter earnings, which are expected to be announced in mid-August.
According to the GF Value line, Tencent is significantly undervalued, with a fair value estimate of $77.99 per share compared to the current price of ~$43 per share.
