Equity Research Analysis: Tencent Holdings and Its Market Position

Broker: OCBC Investment Research
Date: 14 November 2024

Introduction

As we navigate through the intricate world of financial markets, understanding the dynamics of leading companies becomes crucial for investors. In this comprehensive analysis, we delve into the financial intricacies of Tencent Holdings, a behemoth in the communication services sector in China. This report is based on the latest research by OCBC Investment Research, dated 14 November 2024.

Tencent Holdings: A Deep Dive into Its Business and Financials

Tencent Holdings, a titan in China’s communication services, continues to be a preferred choice for investors. The company is well-positioned to leverage long-term growth drivers such as advertising and financial services, particularly as its domestic gaming business reaches maturity. Tencent’s strategic capital allocation to growth businesses and its ability to sustain long-term earnings growth are key pillars of its investment thesis.

Financial Performance and Growth Drivers

In the third quarter of 2024, Tencent reported an 8% year-on-year revenue increase, aligning with consensus estimates. Gaming revenue grew by 13% YoY, marketing revenue slightly exceeded expectations with a 17% YoY increase, while Fintech and Business Service (FBS) rose by a modest 2% YoY. Notably, advertising revenue saw a significant boost, driven by Video Account ads growing over 60% YoY.

Gross profit margin increased by 3.6 percentage points to 53.1%, with adjusted net profit and earnings per share rising 33% and 36% YoY respectively, surpassing consensus estimates by 10% and 11%. This performance was bolstered by higher income from associates and investment gains.

Robust Growth in Gaming and Advertising

Tencent’s online games revenue accelerated, with domestic games revenue increasing from 9% in 2Q24 to 14% in 3Q24. This growth was driven by new launches like Dungeon & Fighter and strong momentum in flagship games such as Honor of Kings and Peacekeeper Elites. Deferred revenue growth also accelerated, indicating strong future prospects for the gaming segment.

Looking forward, Tencent has a strong pipeline of games, including titles like One Piece Mobile and Valorant, with DnF Mobile set for a major update in January 2025. The company’s online advertising revenue is poised to benefit from an improving macro environment, leveraging its large language model Hunyuan, Video Accounts, and Weixin Search.

Strategic Initiatives and Market Position

Tencent continues to deliver sustainable quality earnings growth despite a challenging macro backdrop. The company has demonstrated an ability to expand margins and sustain growth through strategic focus on high-quality revenue streams. Its share buyback program, targeting over HKD100b, is on track, providing support to share price and enhancing shareholder return.

With a business model that benefits from both cyclical recovery and defensiveness in gaming, Tencent remains a preferred play among internet and platform companies. The stock is trading at an undemanding valuation of 15x forward P/E, below historical averages.

ESG Considerations and Risks

Tencent’s ESG profile highlights several challenges. The company faced significant layoffs in 2022, raising concerns about employee morale and job security. Moreover, Tencent was fined CNY2.9b for regulatory lapses in its payment services. Despite these issues, Tencent’s corporate governance is considered average, with improvements in executive pay disclosures and board composition.

The company handles vast volumes of end-user data, necessitating robust data privacy measures. Tencent employs industry-standard practices like data encryption to mitigate privacy-related risks.

Potential Catalysts and Investment Risks

Several potential catalysts could drive Tencent’s growth. Accelerated growth in its payment, cloud, and subscription businesses, as well as successful international expansion, could reignite user growth and engagement. Additionally, stronger-than-expected advertising growth could enhance earnings.

However, Tencent operates in sensitive areas that might face regulatory challenges from the Chinese government. Poor performance of legacy games or disappointing new releases could slow revenue growth. Prolonged macroeconomic challenges also pose risks.

Final Thoughts

OCBC Investment Research maintains a BUY rating for Tencent Holdings, underscoring its potential for sustainable growth and attractive valuation. With strategic initiatives and a robust pipeline, Tencent is well-positioned to navigate the evolving market landscape, making it a compelling choice for investors.

This report provides a detailed analysis of Tencent Holdings, capturing key financial metrics and strategic initiatives that underscore its market position. Investors should consider these insights while making informed investment decisions.