Wall Street Highlights – Equity

Tencent reported a 1Q operating profit beat while revenue resumed double digit yoy growth, with adj. operating profit grew 32% yoy (vs. +25% of GSe/+24% of V.A.); adj. operating margin expanded by 5.3ppts yoy to 32.3%, the highest level since 2Q20. Management’s forward commentaries have reinforced GS constructive view on Tencent namely: (1) Profitability and margin yoy improvement to continue over 2023 (GSe +3.4ppts net margin expansion for FY23E) as Tencent expands into growth areas with well contained incremental investment (e.g. eCommerce live streaming) and ongoing cost discipline initiatives (no. of employees -9% yoy in 1Q), driving net profit acceleration (+31% yoy in 2023E, in addition to 13% revenue growth); (2) Enhanced visibility in game revenue recovery across both legacy (ARPPU expansion on monetization despite some time spent shift) and pipeline (16 domestic pipeline with Banhao) and international market share gain, on top of solid +17% qoq growth (or +Rmb15bn qoq) in deferred revenue, to drive +10% games revenue for FY23E (prior +9%); (3) Ad to see sequential acceleration (GSe 2QE +24% yoy, FY23E +21% vs. prior +22%), driven by Video Account (VA) ramp-up (11% of 2QE ad revenue), ad budget gain from eCommerce platforms during 6.18 festival, and lapsing of the relatively softer-than-expected 1Q/higher base given the Winter Olympics in 1Q22, though GS note the expansion in ad gross margin could be delayed by quicker recovery of the lower-margin ad network business; (4) Cloud to experience manageable impacts (few basis points impact to group revenue) from recent industry price cuts applied to certain long-term IaaS contracts generally purchased by small/medium-sized enterprises, with higher adoption to drive a return to healthy mid-teens growth for FY23E after returning to positive growth in 1Q23. Longer-term, management sees the progress on Tencent’s foundation model development on-track.

Maintain Buy with revised TP of HK$443 per share from HK$442. Following the share price pullback and alleviation of prior investors’ concerns on game (diverging trend between grossing and engagement) and cloud (positive growth despite softer industry outlook), with Tencent’s ahead-of-peers earnings growth trajectory, and Tencent’s buyback to resume post results (with further onshore cash converted to offshore for buybacks/dividends/acquisitions), GS believe risk-reward remains favorable for Tencent (18x 2023E P/E, or 15x if excluding investments vs. 2023-24E net profit growth of 25%). GS see Tencent as a key advertising recovery proxy in internet mega caps. Despite an uneven pace of consumption recovery dictated by scenarios/categories that will persist over 1H23E, GS believe Tencent’s unique Weixin ecosystem and ramping up of Video Account (VA) inventory where GS estimate VA ads to reach Rmb11bn in 2023E, will help drive the re-acceleration of its ahead-of-industry advertising revenue. These, together with multiple games in the pipeline to be released in a re-based 2023, recovering growth profile for fintech and cloud and effective cost-discipline initiatives, will pave the way for a highly visible path towards 2023E net profit acceleration (GSe: +31% yoy), in GS view.

GS keep their 2023-25E total revenue largely unchanged and raise their net profit by 1-2% over 2023-25E on disciplined cost control. GS expect net profit growth to outpace topline in 2023E, on favorable revenue mix with increased revenue contribution from margin-accretive business, better operating leverage and lasting benefits of cost control initiatives implemented since 2H22.

Stock: 0700.HK

Stock Rating: Buy

12m Price Target: HKD443.00