Tencent Holdings Ltd 00700 – Trailing PEG and Intrinsic Value

Mobile Messaging App

Tencent is often compared to Facebook, since its mobile messaging apps dominate the China’s social networking market. Last quarter, its flagship app WeChat hit 938 million monthly active users (MAUs), its older QQ messaging app reached 678 million MAUs, and its Qzone social network had 632 million MAUs.

Video Game Publisher

However, that’s not all — Tencent is also the biggest video game publisher in the world, and its portfolio of blockbuster games include e-sport favorite League of Legends and the mobile hit Clash of Clans.

 

The robust growth across its social networking and gaming businesses is also reflected in its stock price.

The growth of WeChat as an all-in-one “super app” is making it a top stop for internet advertisers (much to Baidu’s chagrin), while new Chinese games like Honor of Kings and Dragon Nest Mobile are holding its domestic rivals at bay.

However, my personal take is that gaming industry is typically a low moat business, where customers are extremely fickle.

Nevertheless, its business (if we compare to the US model) has aspects of Facebook, WhatsApp, Youtube, PayPal, Apple Music plus its gaming business all rolled into one.

Tencent’s revenue and earnings respectively rose 48% and 42% in 2016. Looking ahead, analysts expect its revenue to rise another 47% and for its earnings to climb 43% — which are incredible growth figures for an 18-year-old company.

 

Tencent Holdings Ltd 00700 is traded on the Hong Kong Stock Exchange.

Financial statistics

A quick study on the financial statistics of Tencent Holdings Limited (data below was obtained in Yahoo Finance on 27 Sept 2017).

When looking at growth stocks, I try not to look too deeply into their valuations (else I will be sorely disappointed). Let’s look at its profitability and see if it justify the price.

1. The Profit Margin and Operating Margin is definitely high.
2. The Return on Equity is good (near 30%) and FYI better than Alibaba’s.
3. The balance sheet is strong. The resultant cash (after deducting debt is now HKD 2.29B.
4. Total debt/equity level is not exactly low. Not good but very bad.
5. The current ratio is not good at 1.36. Not good but just slightly below acceptable levels. Note:  Acceptable current ratios vary from industry to industry and are generally between 1.5 and 3 for healthy businesses.
6. Tencent offers very little dividend.

Financial Historical Data

If Tencent is a Student. He/she would be in the Gifted Programme. The perfect A kind of student who never ever perform poorly.

Just looking at its historical revenue, net income, earning per share and free cash flow above – the growth is definitely incredible (esp. since it is a large cap. stock).

Top and bottom lines are growing at 40% to 50% annually at the current time!

The current annual TTM Revenue and TTM Net Income are approx. USD 28.7 billion and USD 8.1 billion! It’s 2016 revenue was USD 22.89 billion. Alibaba’s 2017 revenue was USD 23.86 billion.

However, that is still small compared to Apple whose 2016 revenue was USD 215.6 billion.

Nevertheless, ROA, ROE and ROIC have moderated over the years. But its TTM ROE at 30.28 is still very good. Making it a growth stock. The key metric of ROIC at >20 is also great.

The growth is also no debt-fueled.

Its balance sheet is not exactly great but marginally below acceptable levels. The current ratio is marginally below the acceptable level. Acceptable current ratios vary from industry to industry and are generally between 1.5 and 3 for healthy businesses. The Debt/Equity ratio is also slightly above the ideal level of below 0.4. From a pure risk perspective, lower ratios (0.4 or lower) are considered better debt ratios.

The narratives and figures above show that the company has a high return on capital / low capital expenditure business model.

 

Coming back to growth. Given the huge market cap. size of the stock (at HKD 3.19T which is USD 410 billion), the growth is astonishing. Over a ten-year period, its EPS has an average growth rate of 43%! It is Big and Growing Fast.

Trailing PEG and Intrinsic value

Let’s do a quick study on the trailing PEG and intrinsic value of Tencent Holdings Ltd.

1) Trailing PEG

P/E: 50.6
Dividend Yield (%): N.A.
EPS compound growth rate (10 yrs): 43.26%
The trailing PEG will be 50.6/(43.26+0) = 1.16. Which is not good (> 1), however, it is very close to ok.

2) Intrinsic Value

I am going to use 2 methods to calculate the intrinsic value.

Method 1

First, let’s look at the estimated 10 years earnings growth. Given EPS and a PE ratio, the stock price can easily be calculated for any company. Using the below formula.

F = P(1+R)N where:

• F = the future EPS
• P = the starting (present) EPS (HKD 4.87)
• R = compound growth rate (Using the 10 yrs EPS CAGR which is 43.26%. However let’s take a 20% discount, and use 34.6%. as I am not really sure if growth can be maintained.
• N = number of years in the future (5)
  Estimated future EPS: HKD 21.5

I will be estimating the future PE of Tencent Holdings Ltd to be 41.59 (See below data from Morningstar) – average of the PEs from 2007 to 2016.

Future Stock Price
P=EPSxPE

P = future stock price
EPS = future EPS
PE = future PE
Hence future stock price of Tencent is 21.5 x 41.59 = 894.19

Intrinsic Value
P=F/(1+R)N

P = present (intrinsic) value
F = future stock price (894.19)
R = MARR (15% or 0.15)
N = Number of years (5)
Hence, the intrinsic value of Tencent is HKD 445.

Given that the share price of Tencent Holdings Ltd 00700 on 27 Sept 2017 is HKD 338.400, there appears to be a margin of safety.

 

Method 2

However, if we factor in Risk-Free Rate, Equity Risk Premium, Beta, Operating Cash Flow and Total number of Shares Outstanding, the intrinsic value of Tencent Holdings Ltd 00700 is HKD 320.37 (see below). Then there is no a margin of safety.

 

 

Look, I don’t intend to purchase Tencent stocks given the huge run-up in its share price. However, it is worth noting its intrinsic value and to pick it when markets decline.