Buy Baidu, Alibaba, And Tencent To Benefit From China's Online Boom

Summary

• Baidu - "The Google of China" and so much more.
• Alibaba - "The Amazon of China" rapidly expanding in South Asia.
• Tencent - "The Facebook of China" with a huge gaming business.
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This article first appeared on Trend Investing on October 15, 2018; therefore all data is as of that date.

The current negative sentiment especially in China provides an opportunity to make an entry into the so-called "BAT" stocks. The BAT acronym refers to Baidu Inc. (BIDU), Alibaba Group Holding Ltd. (BABA) and Tencent Holdings Ltd. [HK: 0700] (OTCPK:TCEHY), three of China's largest internet stocks often likened to Alphabet (GOOG) (GOOGL), Amazon (AMZN), and Facebook (FB).

Due to the US-China trade war, Chinese stocks have been heavily sold off (down 13-21% YTD depending on the index). The BAT stocks are currently all trading very near to their one-year lows despite a strongly growing internet economy in China. This allows investors an opportunity to buy in at reasonable prices. In the short term, the trade war dramas will determine if the BAT stock prices move higher or lower.

MSCI China All Shares and MSCI China A International Indices - As of September 28, 2018

Source: MSCI

China's internet is booming

China now has over 800 million internet users and is growing fast, as the huge Chinese middle class urbanize and modernize. Penetration is now at 57.7%, and 98% of them access the internet via a smartphone.

Source

Given the penetration rate is now at ~58% in China there should be still room for at least 15 years of strong growth before they reach saturation levels similar to the US at 89% adoption rate (the US took from 2002 to 2018 to move from 58% to 89% penetration rate - 16 years). Additionally with 5G arriving as soon as 2019, consumers will come to rely on the internet (and hence spend online) more and more. The BAT stocks are the most likely to benefit from this in China, due to their enormous reach and market share dominance.

The BAT stocks - China's internet giants

Baidu - "The Google of China" - USD 200.77

Baidu 5-year price chart

Source: Bloomberg

Baidu is China's largest search engine, and aptly named the "Google of China." Around 80% of all online search (phone or PC) in China is done via Baidu. Baidu offers consumers so much more such as - Social media (Baidu Post Bar or Baidu Tieba), Baidu Encyclopedia (like Wikipedia), Baidu Knows (bulletin board), Baidu Maps, entertainment, Baidu Mobile Assistant (app center), Baidu Takeaway, Baidu Wallet, and Baidu Cloud. Baidu also owns a large stake (58%) in iQiyi (IQ) (The Netflix of China). Finally, Baidu has recently cemented their place in China for ride-sharing and autonomous driving - two large potential future growth areas.

Current market cap is US$71.55b. 2019 P/E is 20.8 with an 18.88% net profit margin forecast. Analyst's consensus estimate price target is US$295 representing 47% upside.

Baidu financials summary chart

Source: 4-traders

Alibaba - "The Amazon of China" - US$144.30

Alibaba 5 year price chart

Source: Bloomberg

Alibaba is China's online "Amazon of China" giant with 58.2% share of all China retail e-commerce sales in 2018. They own two major online shopping sites - Taobao (consumer-to-consumer commerce), and Tmall (business-to-consumer). These businesses provide the vast majority of Alibaba's revenue. In Tmall, Alibaba receives a commission on each transaction as well as charges subscription fees to sellers who maintain storefronts in the marketplace. In Taobao, Alibaba makes money by selling ads. Alibaba also has a large and growing cloud business, as well as an interest in Alipay (via Alibaba's ~33% stake in Ant Financial).

Alibaba has also made very significant other investments that will boost near-term revenue growth. For example, Lazada is the Alibaba of South Asia and is now 100% owned by Alibaba. As of August 2018, Lazada is the largest e-commerce operator in Malaysia, Vietnam, Thailand and the Philippines, based on average monthly web visits. They are also big in Indonesia. Alibaba also has investments in ride-sharing app Lyft (LYFT).

Source

Current market cap is US$ 381b. 2019 P/E is 45.3 with a 15.54% net profit margin forecast. Analyst's consensus estimate price target is US$224 representing 55% upside.

Note: 2020 P/E is 29.6.

Alibaba financials summary chart

Source: 4-traders

Tencent - "The Facebook of China" - US$37.87

Tencent 5 year price chart

Source: Bloomberg

Tencent is the Facebook of China and owns the immensely popular social platform and messaging service WeChat. The main income comes from advertising services similar to Facebook. Tencent's WeChat Pay is also enormously popular.

Tencent's other massive business is online games such as Clash of Clans, etc. This sector has come under some Government scrutiny in recent times, however, this should soon pass.

Tencent's revenue breakdown

Source: Tencent Q2 2018 presentation

Current market cap is US$360b. 2019 P/E is 24.2 with a 23.81% net profit margin forecast. Analyst's consensus estimate price target is US$56.55 representing 49% upside. You can view the company presentation here.

Tencent financials summary chart

Source: 4-traders

Other notable China stocks to consider at this time

• CTrip (CTRP) - Set to boom as a result of China's middle class-led tourism boom. One of the strongest trends in China after the online boom and the EV boom.
• Baozon (BZUN) - The Shopify of China.
• BYD Co. (OTCPK:BYDDF) (OTCPK:BYDDY) - The global EV giant leading China's EV and energy storage booms.

Risks

• New foreign entrants to what has largely been a closed market. This may happen one day, but the three BAT stocks are already very well established with market share and brand name dominance.
• Chinese stocks are not always as opaque or transparent in terms of their accountancy, etc.
• The Chinese Government can at any time crackdown on the internet sector, as they are currently doing to some extent with online gaming.
• US-listed Chinese stocks carry some additional risks.
• A deterioration in the US-China trade war may further worsen sentiment and cause a China slowdown.
• The usual stock market risks.

Further reading

• China Can't Stop Falling: Tencent Is Still A Conviction Buy.
• October 11, 2018 - Trump and China’s Xi to meet in bid to end trade war tensions.

Conclusion

The current China market downturn (caused mostly by the China-US trade war) has resulted in the BAT stocks' prices falling significantly to near their yearly lows. A worsening trade war may impact China adversely, and hence impact the BAT stocks; however, they are generally not otherwise impacted by trade with the US. A US-China trade peace deal should result in a very strong rally in Chinese stocks.

The advantage of the Chinese internet stocks is that there is a clear 15-year runway of growth until they reach saturation levels similar to that of the US. The rising middle class of China is also a strong tailwind. The disadvantage lies around China risks such as the current trade war.

Valuations are now reasonable especially given their high growth and large moats as the three largest China online stocks.

Certainly investing in China-related stocks will not suit everyone; however, the opportunity is now there for those that can accept some of the additional risks. I view the current fall as a chance to take an initial position in all three BAT stocks at reasonable valuations.

As usual, all comments are welcome.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

Disclosure: I am/we are long ALIBABA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.