This year has been brutal for Chinese tech stocks due to escalating trade tensions and a depreciating yuan. But many high-growth tech stocks were tossed out with the bathwater and now trade at historically low valuations. Let’s check out three hated stocks that could rebound sharply in 2019 as the near-term headwinds fade.
Tencent (NASDAQOTH:TCEHY), the largest video game maker and social media company in China, lost 30% of its value this year. The biggest challenge for the company was a government crackdown on video game addiction, which included a temporary freeze on all new gaming approvals and forced companies to impose tighter age and playtime restrictions.
That crackdown caused the growth of Tencent’s online gaming revenue, which accounted for nearly a third of its top line last quarter, to drop from the positive double digits to a single-digit decline. Its total revenue rose 24% annually last quarter on the strength of its advertising business, but that represented its slowest growth rate in three years.
To counter that slowdown, Tencent restructured its businesses to focus on the growth of its digital platforms, cloud services, online payments, and other higher-growth units. It also reduced its spending on the development and marketing of new games. This strategic shift enabled Tencent to post 30% earnings growth last quarter (15% excluding investment-related gains), which crushed analyst expectations for single-digit growth.
Chinese regulators are expected to resume new gaming approvals in the first half of 2019. When that happens, Tencent’s gaming revenue growth will accelerate again as it faces easy year-over-year comparisons — which should cause the stock to rally.
This has also been a year to forget for JD (NASDAQ:JD), the second largest e-commerce player in China after Alibaba, as its stock dropped 50% on concerns about decelerating growth, surging expenses, and an unresolved rape allegation against its founder and CEO Richard Liu. But that decline also reduced JD’s price-to-sales ratio to less than 0.5 — a fire-sale valuation for a company expected to generate more than 20% revenue growth next year.
JD’s growth in revenue, gross merchandise volume, and active customers all decelerated over the past year as demand for large-ticket consumer electronics and appliances waned. Its gross and operating margins also contracted last quarter as it invested more money into its online marketplace, digital services, and logistics network.
However, JD believes that it can grow its higher-margin service revenue (which surged 49% year-over-year last quarter and accounted for 10% of its top line) by offering its logistics services to third-party retailers; expanding its Prime-like “JD Plus” program; and launching more “mini programs” on Tencent’s WeChat, the top mobile messaging app in China.
The growth of that higher-margin revenue could offset JD’s slower marketplace sales, boost its margins, and generate more consistent earnings growth over the next few quarters. That growth would cause the stock to rally, especially if Liu is exonerated.
Baidu (NASDAQ:BIDU) owns the top online search engine in China, which is tethered to an ecosystem of portals, mobile apps, and cloud services. Yet Baidu’s stock slumped more than 20% this year on concerns about weaker ad spending, the depreciation of the yuan, and Alphabet‘s Google potentially returning to China with a censored search engine.
Some of those concerns are valid, but Baidu remains the 800-pound gorilla of China’s online advertising market. Its online marketing revenue grew 18% annually last quarter, its number of active online marketing customers climbed 7%, and its revenue per online marketing customer jumped 12%. Its traffic acquisition costs accounted for only 11% of its revenue, so it clearly isn’t breaking the bank to lock in those customers. Baidu’s total revenue rose 27% during the quarter, and its non-GAAP net income surged 47%.
Those growth rates look solid, but Baidu expects its growth to decelerate in the fourth quarter. That conservative forecast kept investors away from the stock, but analysts still expect its revenue and earnings to rise 16% and 11%, respectively, next year in dollar terms. Those are still decent growth rates for a stock that trades at 17 times forward earnings.
Baidu is often considered a bellwether of the Chinese tech industry, so any whiff of progress in the trade talks between the U.S. and China will likely cause this stock to rally.
Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Leo Sun owns shares of Baidu, JD.com, and Tencent Holdings. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Baidu, JD.com, and Tencent Holdings. The Motley Fool has a disclosure policy.
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