Investors rushing back into Chinese technology stocks on recent market upgrades face a pitfall in the form of weak corporate earnings. The latest results from Tencent Holdings and JD.com show it may still be a falling-knife market.
The two industry stalwarts missed the market consensus by a wide margin in their first-quarter performance, with the full brunt of lockdowns in Shanghai and economic toll yet to be accounted for. That’s an ominous sign for Meituan and Alibaba Group Holding, which will issue their report cards this week.
China’s hardline zero-Covid strategy in tackling the Omicron infections suggests President Xi Jinping is prepared to sacrifice growth to burnish his reputation in controlling the pandemic as he seeks a third term in running the country. The ensuing losses in the manufacturing and services industry have fanned recession risks.
“Even where things are now, there are still places being locked down and supply chain and manufacturing disruptions,” Laura Wang, chief China equity strategist at Morgan Stanley, said at a media briefing on Friday. “The impact of earnings is not being fully priced in by markets yet.”
The MSCI China Index, which tracks 744 stocks with more than US$9.4 trillion of market value, has weakened 19.8 per cent this year to wipe out US$2.2 trillion of value, according to Bloomberg data. Its three biggest constituents – Tencent, Alibaba and Meituan – sank by 20 to 26 per cent.
Corporate earnings are the next shoe to drop in the current bearish market sentiment, following the Federal Reserve’s aggressive rate-hike campaign and China’s draconian zero-Covid policy, according to strategists at Montreal-based research firm Alpine Macro. The current lockdowns have slowed the Covid-19 spread but at the cost of another sudden stop in all economic activity, it said.
“China’s current open-ended mobility restrictions have crushed consumer sentiment and spending intentions, creating a vacuum in domestic demand,” strategists including head of asset allocation Caroline Miller wrote in a May 18 report. “The private sector is poised to suffer another wave of insolvencies, and the recent de-rating in Chinese earnings expectations has more downside.”
Tencent’s net profit declined 51 per cent to 23.4 billion yuan (US$3.5 billion) for the three months ended March 31, versus consensus estimates of 29.3 billion yuan. E-commerce operator JD.com recorded a 3 billion yuan loss, while analysts predicted a 383 million yuan profit. Revenue at both companies grew by the slowest since they became public listed companies.
Meituan will report its quarterly results on May 23, with analysts forecasting an 18 per cent drop in earnings. Alibaba, the owner of this newspaper, is expected to post a 273 per cent gain in earnings, after four consecutive quarters of contraction.
“The risk of Alibaba and other Chinese tech companies negatively surprising the market with weak forward guidance, which leads to deratings of their stocks, is indeed substantial,” said Redmond Wong, market strategist at Saxo Markets.
Some analysts have become more positive about Chinese stocks amid signs Beijing is ramping up its support for the economy, including last week’s cut in five-year loan prime rate, a local benchmark tied to mortgage financing. JPMorgan Chase upgraded Chinese tech stocks on May 16, two months after deeming the sector “uninvestable”.
London-based research firm TS Lombard earlier this month raised its call on China to “moderate positive” from “neutral” on a tactical basis, saying valuations already reflect much of the negative news. Current disappointing economic performance will restrain new political interventions in the economy in the near term, it added.
Top Chinese tech executives, however, remain cautious about how fast China’s policy support can filter into the real economy.
It will take some time for the corrective measures to be turned into normalised regulation, Tencent president Martin Lau Chi-ping said on an earnings conference call on Wednesday. Chief strategy officer James Mitchell said its targets and outlook for this year will depend on how quickly Covid-19 is brought under control.
About 86 per cent of all Chinese onshore and offshore firms have reported their earnings for the March quarter, according to Goldman Sachs research as of May 20. Earnings rose an average of 2 per cent, versus consensus estimates of 9 per cent for MSCI China Index, according to data compiled by the US bank.
Goldman last week trimmed its forecast for China’s economic growth for this year to 4 per cent from 4.5 per cent to account for the cost of lockdowns. Over the past week, earnings of Chinese companies have been scaled back by more than 7 per cent on a one- and three-week rolling basis, it noted.
Profit estimates for the MSCI China Index are still being cut significantly, and that could continue at least through May, said Morgan Stanley’s Wang, who remains equal-weight on Chinese equities.
“We need more patience even though we believe we might be in the final leg of a very long bear market for China,” said Wang. “Near term, there is some chance for the market staying very volatile. We want to be cautious and wait for that true inflection point.”