(Bloomberg) — The rebound in Chinese stocks from multi-year lows may run out of steam unless domestic tech giants manage to post profits next week.
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Index heavyweights Tencent Holdings Ltd. and Alibaba Group Holding Ltd. will both report results next Tuesday, followed by JD.com Inc. and Baidu Inc. two days later. These four companies alone represent more than a quarter of the MSCI China index.
The earnings dashboards come at a crucial time for the country’s main stock indicators, which recently entered a bull market but are still about 40% to 60% below their highs set in early 2021. A key question is whether the rebound, driven in part by cheap valuations and a rotation out of Japan, is sustainable or will once again be punctuated by disappointing results.
“If we see these benefits play out, the momentum will continue,” said Sean Taylor, chief investment officer at Matthews Asia in Hong Kong. “At the moment we are seeing signs that earnings are less degraded.”
Chinese tech companies are something of a bellwether for the country’s entire stock market, as they have tentacles stretching across the economy through their online sales, advertising and mobile games. Their shares’ rebound – driven mainly by renewed interest by global funds in China’s largest and most liquid stocks – is facing a profit test as many of them are now technically overbought.
Read more: Chinese tech valuations take a 40% discount compared to their US counterparts
Tencent is expected to report a 6% increase in revenue for the quarter through March, while Alibaba’s sales are expected to rise 5.6%, according to the average analyst estimate compiled by Bloomberg.
Early earnings data haven’t been entirely favorable. Chinese companies have so far recorded a “considerable failure” in their first quarter results, although there was a sequential improvement compared to the previous three months, Morgan Stanley said in a client note last week.
The U.S. bank warned of a continued rally in Chinese stocks at the index level due to overbought technical signals and continued pressure on corporate profits. “We expect rally momentum to ease,” strategists Laura Wang and Jonathan Garner wrote in a note Tuesday.
Members of the MSCI China index that have already announced their first-quarter numbers saw an average 3% decline in earnings per share from a year earlier, with real estate, utilities and materials companies being the worst performers. less efficient, JPMorgan Chase & Co. also said last week.
There is still room for optimism, however, as tech companies were among the best performers last year in terms of profit growth. Forward earnings estimates for an MSCI index of 100 Chinese technology companies have climbed about 20% in 2023, even as forecasts have declined for other sectors, according to data compiled by Bloomberg.
The sector also remains relatively cheap, even after the Hang Seng Technology Index’s 13% gain since late March. Even though the forward price-to-earnings ratio increased 16-fold, it remains below the one-year average of 18 and well below the five-year average of 26.5.
Retailers were quick to take advantage of the positive business developments. Tencent shares were boosted by news that the company is set to launch the long-awaited Chinese version of Nexon Co.’s Dungeon & Fighter mobile game this month, a title that will help revamp its aging portfolio. The stock of Xiaomi Corp. hit its highest level in two years after the smartphone maker reported better-than-expected initial orders for a new electric vehicle.
Still, investors say they need sales growth to bolster their conviction in the technology. Results from Tencent and Alibaba missed analysts’ estimates for the fourth quarter, and disappointing China retail sales data released last month is raising concerns.
“The overall backdrop for the Internet industry hasn’t always been strong,” said Vivian Lin Thurston, a fund manager at William Blair Investment Management in Chicago. E-commerce companies, as a proxy for China’s overall retail market, are unlikely to see a robust recovery for now, she said.
Skeptics also say that profitability gains have been fueled primarily by cost reductions rather than increased sales or greater pricing power.
“While there is always room to cut costs, this is not a sustainable source of profit growth,” said Nicholas Chui, a fund manager at Franklin Templeton Investments in Hong Kong. “Investors are rightly looking for more replicable sources. »
(Updates to add comments from strategists in eighth paragraph.)
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