Last week, U.S. stock indices hitting fresh records following the strong October jobs report helped investors gloss over some negative developments on the other side of the Pacific. Relevant benchmarks for U.S.-listed Chinese stocks (CQQQ)(FXI) closed positive as well. The Chinese Internet sector representative ETF, the KraneShares CSI China Internet ETF (KWEB), ended up 1.76 percent for the week.
Over the weekend, market players had to digest the weak Chinese Industrial profit data for September which was released on Saturday, October 26 (U.S. time). Profits at China’s industrial enterprises declined 5.3 percent on a year-on-year basis in September, marking the steepest contraction in four years and further dragging the year-to-date profitability to -2.1 percent.
Delving deeper into the statistics, it seemed enterprises involved in petroleum, coal and other fuel processing suffered the worst with profitability plunging 53.5 percent in the first three quarters of this year compared to the same period a year ago. Profits in the ferrous metal processing sector shrank 41.8 percent.
With car sales in China continuing its bad streak of negative growth, it was not surprising to read that profits at car manufacturers fell 16.6 percent. Interestingly, sectors vulnerable to the fallout from the trade war between the U.S. and China did not do too badly actually. Profits in the textile industry were reduced by 4.3 percent while manufacturing profits declined 3.9 percent in the first nine months.
Another disappointing news came on Wednesday, October 30 (U.S. time), with the National Bureau of Statistics announcing (content in Chinese) China’s official manufacturing Purchasing Managers' Index ('PMI') falling deeper into contraction territory at 49.3 in October, lower than September’s reading of 49.8, against consensus estimate for 49.9. This marked the sixth consecutive shrinkage, providing another data point signaling a more challenging business climate.
China's services sector which has been counted upon to augment the economic growth disappointed as well. The official non-manufacturing PMI remained in the expansionary territory but fell to 52.8, the lowest since February 2016. This missed the consensus estimate which had the reading unchanged from 53.7 in the previous month.
The saving grace came a day later when the privately compiled Caixin China General Manufacturing PMI provided a contradictory and positive reading for October at 51.7 from 51.4 in September. This marked the highest reading since February 2017. The sub-indices revealed an even more optimistic environment. Dr. Zhengsheng Zhong, Director of Macroeconomic Analysis at CEBM Group said:
"The subindex for new orders stayed in positive territory and rose to the highest level since January 2013. The gauge for new export orders returned to expansionary territory and reached the highest point since February 2018, due likely to the U.S.’ move to exempt more than 400 types of Chinese products from additional tariffs.
Production growth accelerated further. The output subindex stayed in positive territory and rose for the fourth straight month, hitting the highest level since December 2016. As new orders grew at a faster pace in October, the measure for stocks of finished goods dipped into contractionary territory."
The feat is highly remarkable, considering that Vietnam, the country where it was often reported that manufacturers looking escape the additional import tariffs have relocated to, has seen weak manufacturing PMI since late 2018 and the readings worsening in the past few months. The Vietnam Manufacturing PMI is compiled by London-based data analytics firm IHS Markit Ltd. (INFO).
Source: IHS Markit
Contrary to media reports that China is "eager" to close a trade deal with the U.S. to "avoid" a further worsening in its economic growth slowdown, Chinese officials are apparently not that worried about the latter. Local authorities tightened winter environmental regulations that could curb industrial and commercial activities. In addition, there would be production restrictions imposed on specific industrial sectors, including steel-making and coking.
The discrepancy between the official Chinese PMI reading and the privately compiled Caixin one could be explained by the fact that the former polls a larger proportion of big companies and state-owned enterprises ('SOE') than the latter. The earlier released China industrial profits data revealed that profits at state-owned enterprises dropped 9.6 percent in the first nine months while profits at private business actually increased 5.4 percent. This corresponds with the weaker reading from the SOE-heavy official PMI.
Soft PMI reading or otherwise, Chinese consumer confidence has stayed rather resilient. The consumer confidence index remained on an uptrend from May 2018, even as the trade war plummeted stock markets globally in the second half of 2018. Retail sales growth of consumer goods, while less rapid than in the past, has been fairly decent at high-single digits. If automotive sales that have been in the doldrums were taken out, retail sales would have been much better. This bodes well for the bevy of Chinese e-commerce companies.
Source: Deloitte/National Bureau of Statistics
Unfortunately, Chinese stocks or anything related to China tend to suffer from a negative perception problem. Shortly after the discovery of 39 alleged illegal immigrants who were found dead in a lorry in Essex, Britain, several took to Twitter to discuss the incident unfavorably towards China. Even a reputable international media outlet like CNN rushed to publish an article questioning "Why would people from China, the world's second-biggest economy, risk their lives to enter the UK?"
Source: Screenshot from CNN.com
A CNN reporter had the cheek to raise a similar question at the Chinese Foreign Ministry's press briefing on the same day of the article, asking spokesperson Hua Chunying "what 'motivated people from China to want to leave China in such a risky way' despite China's development over the past seven decades." Subsequently, it transpired that some of the alleged illegal immigrants were Vietnamese before the BBC reported a few days later that the UK police "believed 39 people found dead in a lorry were all Vietnamese."
It can be argued that while in this particular tragic incident that the Chinese were not the victims, there were earlier cases where they were. The point is that in this case, it has been established that the Chinese were probably not involved but jumping into conclusion has tarnished China's image among the international communities and possibly stirred up discontent with the government among the Chinese population.
Chinese stocks similarly suffer from such quick condemnation. For instance, whenever there are claims from short sellers of shenanigans happening at Chinese companies, the lack of trust and information gap often causes a prompt sell-down. Management typically doesn't do themselves justice as well, choosing to issue very brief and sweeping responses to accusations, like in the case of live-streaming operator Momo (MOMO) last year. Until the management or their investor relations department put in the effort to engage shareholders or provide more timely communications, Chinese stocks could perennially suffer from the (dis)trust discount.
As explained in a past issue of the Chinese Internet Weekly, I found the KWEB ETF holding the most representative stocks in the sector. As such, an overview of the week's share price movements of the top few holdings of KWEB as compared with the ETF itself is provided as follows for convenient reference especially for the stocks mentioned in this article. In the subsequent sections, I will elaborate on Ctrip's (CTRP) share price outperformance and of course, Alibaba Group's (BABA) Q2 2019 results.
Ctrip.com's 20th-anniversary publicity blitz and name change
October 29, 2019, marked the 20th year since Ctrip.com was founded. There was a raft of articles in the Chinese media reflecting its two-decade journey and achievements. Ctrip itself intensified a publicity blitz and a series of celebratory events to commemorate the occasion, leveraging the anniversary in its marketing. The money spent has already seen returns in the form of share price gains, as the stock rose 9.64 percent for the week, supported by the attention brought about by the strong media coverage.
The Chinese travel giant also formalized its name change to Trip.com Group Limited last week, making it the third major online travel agency to change its name since 2018. While the .com denotes the domain suffix standing for 'commercial', the company said it also represents 'companion', a fitting description for the travel agency. The domain itself was acquired by Ctrip in 2017 and was used by the company to target international customers.
Note that the KWEB ETF performance was also helped by gains in Meituan Dianping (MEIT) (OTCPK:MPNGF) (OTCPK:MPNGY) which is primarily listed in Hong Kong. Its shares had ostensibly appreciated last week as they became available on Stock Connect. According to the Hong Kong Stock Exchange, Stock Connect is a "unique collaboration between the Hong Kong, Shanghai and Shenzhen Stock Exchanges," which "allows international and Mainland Chinese investors to trade securities in each other's markets through the trading and clearing facilities of their home exchange."
Together with phone maker Xiaomi (XI) (OTCPK:XIACF) (OTCPK:XIACY), Meituan Dianping is the first Hong Kong-listed stocks with weighted voting rights to become available to investors from mainland China. The food delivery and life services titan has been on a tear since the beginning of the year, with its share price more than doubling during the period.
Source: Yahoo Finance
Alibaba Q2 FY2020 beats on EPS and revenue
With a well-covered stock like Alibaba, I would briefly state the financial results for the quarter ended September 30, 2019, and go into sharing my thoughts.
- Q2 FY2020 Non-GAAP EPS of $1.83 beats by $0.32; GAAP EPS was $3.85. Revenue of $16.65 billion (+40.0% Y/Y) beats by $180 million.
- Income from operations was RMB20,364 million (US$2,849 million), an increase of 51% year-over-year. Adjusted EBITDA, a non-GAAP measurement, increased 39% year-over-year to RMB37,101 million (US$5,191 million). Note that Alibaba recognized a one-time gain of RMB69.2 billion (US$9.7 billion) upon the receipt of a 33 percent equity interest in Ant Financial on September 23, 2019.
- Annual active consumers on Alibaba's China retail marketplaces reached 693 million, an increase of 19 million from the 12-month period ended June 30, 2019.
- Mobile MAUs on its China retail marketplaces reached 785 million in September 2019, an increase of 30 million over June 2019.
- Core Commerce revenue growth at 40% Y/Y was surpassed by Cloud Computing revenue growth at 64% Y/Y.
The immediate stock reaction post-results was more of a ho-hum, despite the significant beats on EPS and revenue. The reason could be that Alibaba has surpassed consensus estimates on EPS frequently and it had done so with a greater magnitude only recently, in the quarter ending March 2019.
Source: Seeking Alpha Essentials
The same goes for its quarterly revenues, where surprises above 3 percent are quite common. Hence, it's not so much that shareholders were greedy but that they had been 'pampered' by Alibaba's outperformance in the past.
Source: Seeking Alpha Essentials
Although helped by the superior revenue growth in Cloud Computing, non-Core Commerce contribution still pales in comparison to Core Commerce, with its share of revenue at only 15 percent of the quarter's total. Digital media and entertainment, as well as Innovation initiatives and others, the other two carved out non-Core Commerce divisions, posted slower growth at 23 percent and 14 percent respectively.
This is in spite of the Digital media and entertainment division housing heavily-used services like the Youku online video platform that saw average daily subscribers jumping 47 percent year-over-year in the second quarter. The Innovation initiatives division also has the Amap app that Alibaba claims to be the largest provider of mobile digital maps, navigation and real-time traffic information in China by daily active users.
On October 1, 2019, the first day of the week-long National Day holiday in China when a large number of the Chinese drivers typically go on the road, the Amap app achieved a record high of 118 million daily active users. This is an impressive feat considering China's car population at around 240 million (by the end of 2018) and that many households own more than one car to bypass restrictions (e.g. driving the odd number plate on certain days and the even number one on other days) or for different purposes (e.g. family sedan car on weekdays and the SUV on weekends).
Moving on to the cash flow statement, Alibaba boosted the net cash provided by operating activities 51 percent higher from RMB31,407 million in the second quarter of FY2019 to RMB47,326 million (US$6,621 million) in the latest reported quarter. Free cash flow, a non-GAAP measurement of liquidity, in the quarter ended September 30, 2019, nearly doubled, increasing by 90 percent to RMB30,488 million (US$4,265 million), from RMB16,033 million in the same quarter of 2018. The company attributed the jump primarily to its robust profitability growth as well as the timing of capital expenditure spending and licensed copyright acquisition.
An oft-mentioned criticism about the non-GAAP free cash flow figures is that they cannot be trusted fully due to the possibility of "massaging" or manipulation by the executives. However, such moves probably work for a quarter but comparing the same periods, it should still reflect the year-on-year changes. It would be fair to say that such comparisons should be on a full-year basis, and preferably understanding the context, since there could be certain activities during a particular year that skew the numbers. For instance, Alibaba is building an office campus and the timing of when the payments are recognized would have an impact on comps.
Source: Alibaba Q2 2019 results presentation
On strategy, Alibaba executives continued to emphasize during the earnings conference call its ecosystem as its core strength, much like what Apple Inc. (AAPL) is behaving now. Daniel Zhang, the CEO and Chairman of Alibaba claimed that his company "is the only platform to meet the diverse range of consumers' demands in physical goods, local consumer services, and the digital entertainment." He also spoke about driving "user synergy by enabling merchants to cross-sell products and services in the digital economy."
It was also encouraging to hear Daniel Zhang talk about marketing Alibaba's cloud computing technology and big data insights to enterprises as empowering them, as though doing the clients a favor. He said that the adoption of cloud services in China would help lower IT costs, a clear attraction, but the need for the digital transformation of business models and processes as exhorted by the central government in its drive to increase productivity was a stronger motivation. This is a particularly pertinent point if China wants to keep its edge over others as a manufacturing base, especially now that tariffs are seriously eroding its cost-competitiveness.
Source: Boston Consulting Group
With the hyped Singles' Day fast approaching, it was comforting to hear that Alibaba is not about to engage in a price war to the bottom, at least not as a core focus. Daniel Zhang revealed that Alibaba has "worked with many brand companies to tailor-made products exclusive for November 11" and coming up with limited editions. Such merchandise would serve "not only a shopping day but also a marketing day for brands" to enhance their brand value and an opportunity to "engage with new customers," something that incessant price discounting would not achieve.
Outside of the earnings call, Alibaba's tie-up with brands on an exclusivity basis has been regarded as a strong competitive advantage. For instance, its partnership with Japanese retailer Uniqlo has brought (content in Chinese) many of its customers to Alibaba's platforms. Alibaba's clout with brands has been the bane of other e-commerce players which have long complained about the practice. Fast-growing e-commerce platform Pinduoduo (PDD) has to resort to heavily subsidizing iPhones (content in Chinese) to attract new user sign-ups, which partly explains its high expenses.
Disclosure: I am/we are long BABA, NTES, JD, BIDU, INFO, TCEHY. 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.