Alibaba Stock – Which Chinese Stock is a Better Buy?

Tencent Holdings Limited (TCEHY) and Alibaba Group Holding Limited ((BA)(BA)) are two of the largest tech companies in China. They are  growing rapidly and competing evermore intensely with the tech giants in Silicon Valley. TCEHY offers value-added services, internet advertising services, online games and social network services, while (BA)(BA) operates in Core Commerce, Cloud Computing, Digital Media and Entertainment, and Innovation Initiatives and Other segments.

Although  TCEHY and (BA)(BA) have been facing several headwinds since last year, one of the most troublesome being the Chinese government’s escalating scrutiny of the country’s leading tech companies, these companies have  maintained an impressive track record of growth. As they continue to expand their market leadership—reflecting the immense potential of China’s nascent cloud computing and digital platforms—both  stocks should perform well in the long run.

TCEHY has gained 401.6% over the past five years, while (BA)(BA) has returned 272.4%. In terms of their year-to-date performance, TCEHY is the clear winner with 26.2% gains versus (BA)(BA)’s 7.6% returns. But which of these stocks is a better pick now? Let’s find out.

Latest Movements

In December, a Tencent-led consortium exercised its call option to acquire an additional 10% equity interest in Universal Music Group. The long-term partnership should help TCEHY  grow its user base significantly and expand its business opportunities.

In November, Tencent Cloud established Tencent Distributed Database (TDSQL), which has been deployed in the new core system of Bank Neo Commerce in Indonesia. The service success should open more channels for TCEHY to capture new opportunities in the international market.

This month, (BA)(BA) priced  $5 billion of senior unsecured notes. The company intends to use the offering’s t proceeds  for its working capital needs, repayment of offshore debt and potential acquisitions of or investments in businesses.

Last month, The Gross Law Firm, the Schall Law Firm and several other law firms filed class action lawsuits against (BA)(BA) on behalf of certain shareholders of the company. This development could undermine the company’s future growth prospects and severely damage its brand name.

Recent Financial Results

In the third quarter, ended September 30, 2020, TCEHY’s revenue increased 29% year-over-year to RMB125,447 million. Its operating profit grew 34% from its year-ago value to RMB38,116 million, while its operating margin increased to 30% from 29% last year. The company’s net profit increased 32% from the prior-year quarter to RMB 32 billion.

In the fourth quarter, ended December 31, 2020, (BA)(BA)’s revenue increased 37% year-over-year to RMB221.08 billion. Its adjusted EBITDA grew 22% from the year-ago value to RMB68.38 billion, while its adjusted EBITDA margin declined to 31% from 35% last year. The company generated an operating loss of RMB2.04 billion and RMB2.39 billion in the cloud computing segment and digital media and entertainment segment, respectively.

Past and Expected Financial Performance

TCEHY’s revenue and EBITDA grew at CAGRs of 28.3% and 22.6%, respectively, over the past three years. Also, the CAGR of the company’s total assets has been 32.3% over the same period.

Analysts expect the company’s EPS to increase 28.4% in the current year.  TCEHY’s EPS is expected to grow at a rate of 3.7% per annum over the next five years.

In comparison,  (BA)(BA)’s revenue and EBITDA grew at  CAGRs of 41.6% and 19.7%, respectively, over the past three years. The CAGR of the company’s total assets has been 32% over the same period.

Analysts expect (BA)(BA)’s EPS to increase 37.2% in the current year.  (BA)(BA)’s EPS is expected to grow at a rate of 3.5% per annum over the next five years.

Profitability      

(BA)(BA)’s trailing-12-month revenue is 1.5 times  TCEHY’s. But TCEHY is more profitable, with a gross profit margin of 46% versus (BA)(BA)’s 43.3%.

TCEHY’s ROE and ROA of 22.6% and 7.3%, respectively compare favorably with (BA)(BA)’s 15.7% and 4.5%.

Valuation

In terms of forward EV/EBIT, TCEHY is currently trading at 37.09x, 3.8% higher than (BA)(BA)’s 35.73x. Also, in terms of trailing-12-month price/sales, the company is currently trading at 13.05x, 89.1% higher than (BA)(BA)’s 6.90x.

Though TCEHY looks more expensive than  (BA)(BA), we think it’s worth paying the premium considering TCEHY’s significantly higher earnings growth potential.

POWR Ratings

TCEHY has an overall rating of B, which translates to a Buy in our proprietary POWR Ratings system. However, (BA)(BA) has an overall rating of C which represents a Neutral. The POWR Ratings are calculated by considering 118 different factors with each factor weighted to an optimal degree.

TCEHY has a Momentum Grade of B, which is consistent with its price returns over the past five years. In comparison, (BA)(BA) has a Momentum Grade of C.

In terms of Sentiment Grade, TCEHY has a B, in sync with analysts’ expectations about revenue and earnings growth. (BA)(BA) has a Sentiment Grade of C.

Both TCEHY and (BA)(BA) have a Value Grade of C, which is consistent with their higher-than-industry p/e ratios.

Of the 85 stocks in the C-rated China group, TCEHY is ranked #16 while (BA)(BA) is ranked #21.

Our POWR Ratings system has also rated both TCEHY and (BA)(BA) for Quality, Stability, and Growth. Get all TCEHY’s ratings here.  Click here to see the additional POWR Ratings for (BA)(BA).

The Winner

While both TCEHY and (BA)(BA) can be considered  good long-term investments based on their market dominance and diversified business, TCEHY appears to be a better buy despite trading at a significantly higher valuation based on its higher earnings growth potential and higher profitability.

Our research shows that the odds of success increase if one bets on stocks with an Overall POWR Rating of Buy or Strong Buy. Click here if you want to know about other top-rated stocks in the China group.

The POWR Ratings are calculated by considering 118 different factors with each factor weighted to an optimal degree.

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TCEHY shares were trading at $88.35 per share on Thursday morning, down $0.85 (-0.95%). Year-to-date, TCEHY has gained 22.90%, versus a 4.18% rise in the benchmark S&P 500 index during the same period.

About the Author: Imon Ghosh

Imon is an investment analyst and journalist with an enthusiasm for financial research and writing. She began her career at Kantar IMRB, a leading market research and consumer consulting organization. More…

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