Best Chinese tech action: Alibaba or Tencent

Alibaba Group (NYSE: BABA) and Tencent (OTC: TCEHY) are two of China’s largest tech companies. Alibaba is China’s largest e-commerce and cloud services company, while Tencent is a market leader in social media, advertising, games, streaming media, cloud, and fintech.

I compared these two stocks last August and claimed that Tencent’s better diversified business, higher operating margins, and stronger earnings growth made it a better buy than Alibaba. But at the time I made that call, I didn’t expect China to launch a sweeping crackdown on its major tech companies.

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In the past 12 months, Alibaba shares have fallen 22% while Tencent’s have fallen 7%. Alibaba has been hit by an antitrust investigation, a record fine of $ 2.75 billion, new restrictions on its e-commerce business and the suspension of the long-awaited IPO of its fintech subsidiary Ant Group.

Chinese regulators have also blocked Tencent’s proposed merger Huya and DouYu, which is said to have created the best esports streaming platform in the country; temporarily suspended new user registrations for WeChat; and forced Tencent Music waive all of its exclusive music license rights.

These headwinds, along with continued threats to delist shares of Chinese companies listed in the United States, have likely prompted many investors to sell all of their Chinese stocks. It may be a prudent move, but some contrarian investors might be willing to try their luck on these two tech giants while the market looks the other way. Let’s see which stock has the best chance of recovering.

Alibaba loses momentum

Alibaba generates most of its revenue and all of its profits from its core business activity, which includes its online marketplaces, physical stores and logistics subsidiary Cainiao.

Alibaba’s core business activity supports the growth of its cloud, digital media and entertainment businesses, and innovation initiatives. These three small businesses are not profitable by GAAP standards, but Alibaba Cloud’s adjusted EBITA has turned positive in the past three quarters.

A mini shopping cart placed in front of a laptop computer.

Image source: Getty Images.

Alibaba’s revenue rose 41% to 717.3 billion yuan ($ 109.5 billion) in fiscal 2021, which ended in March. Its commercial revenue increased by 42%, supported by the expansion of its low-margin direct and physical sales segments, while its cloud revenue increased by 50%.

However, Alibaba’s increased reliance on its low-margin business operations – along with its fourth-quarter antitrust fine – caused its operating income to fall by 2%. But his adjusted profit, which excludes this fine and his stock-based compensation, still rose 23%.

In the first quarter of fiscal 2022, Alibaba’s revenue grew 34% year-on-year to 205.7 billion yuan ($ 31.9 million). Its commercial revenue grew 35% year on year, but its cloud revenue grew only 29% from a difficult comparison with high usage rates during the pandemic.

Alibaba’s growing reliance on low-margin companies to increase its trading income, continued losses of its three small businesses and other investments have reduced its operating income by 11%. However, his adjusted profit rose another 12% as he bought back more shares.

Tencent also faces unpredictable challenges

Tencent’s revenue grew 28% to 482.1 billion yuan ($ 73.9 billion) in 2020. Its three main businesses – VAS (value-added services, including payments in games and apps), online advertising, and fintech and commercial services (including Tencent Cloud and WeChat Pay) – have increased at double-digit rates.

Tencent’s adjusted operating profit rose 30% while its adjusted profit – which excludes investment-related gains and losses – also rose 30%.

In the first quarter of 2021, Tencent’s revenue increased 25% year-on-year to 135.3 billion yuan ($ 20.6 billion), with double-digit growth in its three core segments, while its adjusted operating profit increased by 20% and its adjusted profit increased by 22%.

These growth rates appear solid, but Tencent’s gaming business slowed in the quarter, facing more difficult post-pandemic comparisons. Tencent still generated nearly a third of its revenue from its video games, which include Honor of kings and Elite Peacekeepers.

This is why the recent buzz surrounding another potential video game crackdown in China, which originated in a retraction Xinhua article that originally called the games “digital opium” – weighed down the stock. Its other unresolved challenges regarding Tencent Music, WeChat and WeChat Pay – which the government wants to regulate closely alongside Ant’s Alipay – have also largely overshadowed the robust growth of its core business.

The evaluations and the verdict

Analysts expect Alibaba’s revenue to grow 30% this year, but its profits to drop 4% as it relies more on low-margin retail and ramps up investment. They expect Tencent’s revenue to grow 22% and 21%, respectively, this year as its three main businesses continue to grow.

Alibaba shares are trading at just 20 times forward earnings, while Tencent has a forward P / E ratio of 26. These valuations seem historically cheap for both companies, but they are tied to flawed estimates that may not fully explain the strong regulatory headwinds. in China and the USA

I wouldn’t touch any of the stocks until those headwinds abated. But if I had to choose one over the other, I would say once again that Tencent’s better diversification, higher operating margins, and stronger profit growth make it the best overall investment.

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Leo Sun has no position in the stocks mentioned. The Motley Fool owns shares and recommends Alibaba Group Holding Ltd. and Tencent Holdings. The Motley Fool recommends HUYA Inc. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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