Tencent and China – Dog days.

China is now a deeply contrarian investment.  

• Disappointing results from Tencent combined with the worsening economic outlook and disappearing data make China a deeply contrarian trade and there is no immediate catalyst to pull it out of its nose-dive.
• Tencent reported Q2 2023 revenues / EPS of RMB149.2bn / RMB2.70 short of revenue forecasts of RMB151.7bn as gaming revenue did not recover as had been hoped.
• Net income (after removing the RMB2.99bn fine) also fell short at RMB29.2bn compared to consensus of RMB32.3bn as a result of the lacklustre recovery seen in Chinese consumer expenditure.
• Online advertising was one bright spot growing 34% YoY but this was mostly due to an easy compare against 2022 when China was still mired in Covid Zero.
• Tencent is doing everything that it can to return to growth and its margins expanded pretty nicely during the quarter but while the economic situation in China continues to unravel, there is little more that management can do other than wait.
• On the economic front, there is nothing but bad news with demographics, debt, youth unemployment, real estate and confidence in the government’s ability to turn the economy around all rapidly eroding.
• To make matters worse, China’s National Bureau of Statistics will now stop reporting youth unemployment which will only lead investors to conclude that things will continue to worsen.
• There is nowhere to hide in the public market.
• This is evidenced by sales of Chinese securities by foreign investors who have now reversed everything that was invested since the government promised in July to support the economy and public markets.
• Pessimism about China is everywhere and is showing up as red flags in surveys of investors.
• For example, a Bank of America fund manager survey showed that 84% of respondents thought that Chinese stocks are in a period of structural derating implying that no one wants to buy China and in fact many are still in the process of selling.
• This is a very far cry from the optimism that I had going into 2023 and has largely been caused by the state’s slowness to take concerted action to turn the economy around.
• Alavan Independent has concluded that loyalty and subservience to the party is seen as more important than economic prosperity meaning that the outlook for a real change is pretty bleak in the short-term.
• Hence it may be a while before President XI changes his mind.
• The sudden reversal of Covid Zero demonstrates that this is possible at any time, but it may take further social unrest to push Mr Xi to switch his priorities.
• Until then, the technology sector is likely to remain in a value trap where managements are powerless to do anything about it.
• I still own Alibaba and, in this environment, it is not impossible that its price-earnings ratio slips into single-figure territory meaning that there is a long wait ahead.
• China is now almost universally despised across the investment landscape, but it is worth remembering that the time to buy is always when things look to be at their worst.
• The problem here is that there is a geopolitical angle to this and politics make investment decisions extremely difficult due to their dependence on personalities rather than logic and hard numbers.
• This is why I am nervous about increasing my weighting towards China.
• However, at some point, the people of China are likely to express their discontent which will force Mr. Xi to properly address the real issues that China is facing.
• I am lucky that I can just sit it out and get paid dividends while I wait.