Michael Vi
Tencent (OTCPK:TCEHY) shares traded up 1.5-2.0% after the Chinese tech giant reported Q4 and FY 2023 results. Although revenue came in somewhat lower than expected, profits surged 23% YoY, comfortably beating consensus. In addition, Tencent surprised markets positively by revealing a $12.8 billion stock buyback program (expected to be up 100% YoY), as well as a 40% jump in dividend payments. Personally, I see the ramp up in distributions as a major bull signal, as I have previously voiced negative commentary on Tencent’s “unappealing shareholder distributions, which certainly are below levels that would justify investing in such a risky equity asset”. Considering updated valuation metrics, most notably a lower risk requirement for the equity, I now estimate the intrinsic value of Tencent to be around $49 per share. I upgrade the stock to a “Buy” recommendation.
For context: Tencent stock has grossly outperformed the broader U.S. stock market YTD. Since the start of the year, TCEHY shares are down about 3%, compared to a gain of almost 9% for the S&P 500 (SP500)
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Tencent’s Q4 Misses On Revenue, But Beats On Profit Expectations
Tencent’s Q4 2023 disappointed expectations on topline, but surprised to the upside on profit: During the period from September through the end of December, the Chinese technology giant reported a 7% year-over-year growth in revenue, achieving RMB 155.2 billion in sales. This was slightly below the analyst expectations, which had anticipated revenues of approximately RMB 157.4 billion, according to data compiled by Refinitv.
With regard to profitability, it is notable to point out that Tencent’s gross profit surged 25% year-over-year, to RMB 77.6 billion. In that context, Tencent management pointed out that throughout 2023, the company had been pushing to expand high-quality revenue streams, while phasing out the lower-quality ones. Moreover, Tencent highlighted the accretive impact of value-added revenue on platforms for which costs have already been incurred in earlier periods (akin to investments). Overall, Tencent expects that the company’s “commitment to cost discipline” will have ongoing positive effect in the future.
The company’s operating income margin for the fourth quarter was 31.7%, up 660 basis points compared tot he same period one year earlier. In terms of dollar value, after taxes, Tencent’s non-GAAP net income was reported at RMB 42.7 billion, a surge of 44% compared to Q4 in 2022.
Tencent Q4 reporting
Higher Shareholder Distributions Favorably Change The Equity Story For Investors
Reflecting on Tencent’s latest results, a major positive investor highlight in the reporting is embedded in the company’s announcement to supercharge shareholder distributions, in my opinion. Overall, Tencent intends to significantly increase its stock repurchase program to a minimum of $12.8 billion in 2024, doubling from similar buybacks in 2023. On top of this, Tencent also suggested plans to increase the annual dividend to equity investors by 40% YoY compared to 2022, distributing close to $4.1 billion over the next 12 months.
Assuming Tencent moves on the announcement and indeed distributes $16.9 billion to investors in 2024, I point out that the company’s equity yield is poised to trend around 5% (referencing a market capitalization of $339 billion as of 20th March 2024).
Tencent Q4 reporting
Discussing the uplift in shareholder distributions, I highlight that Tencent cleared a major hurdle that kept me from investing in the company’s stock. In fact, in late 2023 I argued:
I am cautious to argue that Tencent stock presents itself as a bargain. One major issue that I am seeing with Tencent shares relates to the company’s unappealing shareholder distributions, which certainly are below levels that would justify investing in such a risky equity asset. For the trailing twelve months, Tencent has distributed about $6.2 billion in form of share buybacks and 1.2 billion in form of dividends, partially offset by -$3.4 billion dilution for share based compensation, bringing the net equity payout to about $4 billion only. Compared to a $375 billion market capitalization, the payout is quite unattractive, at ~1% yield.
Admittedly, the fact that Tencent supercharges shareholder distribution not only reflects a positive thesis value, but likely also a negative thesis on growth: When a company returns significant capital to shareholders through dividends or share buybacks, it may indicate that the company has more cash than it can effectively reinvest in its own business. This can be seen as a sign that there are few growth opportunities available, or that the company cannot find investments with attractive returns. But the evidence on the negative growth thesis must yet to be seen. For reference, investors should note that major U.S. companies like Google (GOOG) (GOOGL), Apple (AAPL), and Microsoft (MSFT) have been distributing anywhere between 50-100% of FCF to shareholders for almost a decade, and the companies still manage to materialize attractive organic growth for investors. That said, overall, I think the shareholder distributions are a major positive signal for investors.
Valuation Update: Lower Target Price
I update my EPS projections for the Chinese Tech giant to align my estimates with analyst consensus revision over the past 3 months, according to data collected by Refinitiv: I now anchor on EPS equal to $2.8 for FY 2023, vs $2.5 estimated previously. Moreover, I adjust my EPS input for 2024 and 2025, to $3.24 and $4.19, respectively.
I continue to base my valuation model on – in my opinion – a reasonable 3.5% terminal growth rate (one percentage point higher than estimated nominal global GDP growth). However, as a consequence of the capital distribution announcement, I reduce my cost of equity estimate by as much as 150 basis points, to 10.5%. Overall, I still view Tencent’s risk estimate at a significant premium to U.S. peers, reflecting the heightened regulatory risk overhang in China. For reference, my cost of equity estimate for Google and Microsoft are about 9% and 8.5%, respectively.
Given the adjustments as discussed above, I now calculate a fair implied share price for TCEHY equal to $49, seeing notable upside of about 33% compared to the company’s trading price as of late March 2024.
Refinitiv; Company Financials; Author’s Calculations
Below also the sensitivity table, which tests different assumptions for cost of equity (row) as well as terminal growth rate (column).
Refinitiv; Company Financials; Author’s Calculations
Investor Takeaway
Despite revenue falling slightly short of expectations, Tencent experienced a strong 23% YoY surge in profits, surpassing market consensus. Moreover, the company pleasantly surprised investors by announcing a $12.8 billion stock buyback program, expected to double YoY, alongside a 40% increase in dividend payments, potentially reaching a 5% equity return for FY 2024. Taking into account updated valuation metrics, particularly a reduced risk assessment for the equity, I now estimate Tencent’s intrinsic value to be approximately $49 per share, prompting me to upgrade my recommendation on the stock to a “Buy.”
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.
