I talked about investing in specific trackers when covering 5 thematic funds for the future. I now want to go a bit deeper into my top pick: investing in water.
Last Updated on August 25, 2020 by Mr. FightToFIRE
FANG which is an acronym for Facebook, Amazon, Netflix, and Google(Alphabet) has an equivalent in China: JAT. It stands for JD.com, Alibaba, and Tencent. Just like FANG, they are internet companies that are making huge profits through e-commerce.
Before getting into these three companies, remember one important element.
You cannot forget when dealing with these Chinese giants that Chinese technology stocks are listed in New York through an intermediate “letterbox firm” (a “VIE” entity) based in one of the tax havens.
As a result, shareholders are not direct owners. In theory, the Chinese company (for example, commissioned by the Chinese government) could cut ties with the VIE structure, but in practice, that seems unlikely. This structure nevertheless remains an argument for restricting positions in Chinese stocks.
The Chinese stock market was hit hard by the trade war and its slowing economy. Nevertheless, the Chinese market stays the course and keeps vigorous growth even now during the corona pandemic it recovered remarkably in just a few months.
Consumer-oriented internet shares in particular benefit from this. Thanks to the growth of the middle class, Chinese GDP is increasingly determined by consumption and less by industry. This has been going on for years but appears to have sped up.
You can’t underestimate the effect of this urbanization. In the somewhat lagging ‘smaller’ cities (of tens of millions of inhabitants), consumption could triple in the coming decade (Morgan Stanley, 2018). The internet sector also benefits from rapid digitization in society.
E-commerce already represents a large portion of retail sales. With their huge cash flows, internet giants can invest in innovative activities such as Cloud, data analysis, and artificial intelligence (A.I.). Another strong growth area of expertise, especially for Alibaba and Tencent, is digital payment services, which quickly became established in China. Much faster than in the West.
Optimizing supply chain
JD.com is the largest player in Chinese e-commerce with 334.4 million active customers annually.
Although sales have slowed every fiscal year since the IPO in 2014, the company’s revenue surged in the second quarter of 2020 as more customers turned to order products online following the outbreak of COVID-19.
The Beijing-based online direct sales company reported annual active customer accounts increased by 30% to 417.4 million in the three months through June, helping net revenue increase 34% year-over-year to 201.1 billion Chinese yuan ($28.5 billion). Net income was 16.4 billion Chinese yuan ($2.3 billion), or an adjusted 3.51 Chinese yuan per share.
I can find one reason for this surge in the company’s ability to quickly adapt to the new reality that COVID posed. During the pandemic, JD.com turned to autonomous delivery robots to do the last-mile delivery needs of consumers in Wuhan. This also lessened the blow of the pandemic on the company’s operations.
The e-commerce branch (86% of revenue) achieved a robust revenue growth of 42%. Moreover, the EBITDA margin improved to 41%. Alibaba is taking various initiatives to maintain its market dominance. The rise of newcomer Pinduoduo (NYSE: PDD), specializing in group purchases, can be curbed by daughter Juhuasuan, who is launching a first ‘festival’ on 9 September (such as Alibaba’s successful ‘SinglesDay’ on 11 November). Alibaba also acquires Kaola, the e-commerce daughter of NetEase, for 2 billion. USD. Kaola is the largest online store that sells foreign products in China. By merging with its own activities, Alibaba acquires a market share of 52% in this segment. The strongest growth comes from the Cloud (7% of sales), but 66% growth in the second quarter was disappointing. The ‘digital media and entertainment’ department, including Alibaba Pictures and video service Youku Tu-dou, remains in the red. Alibaba postponed its pledged stock exchange listing in Hong Kong to October. We do not expect that the issue of new shares will weigh on the price. It is less than 5% of market capitalization and Chinese interest will be high, which can lead to a higher valuation. Altaba (formerly Yahoo!) has already sold most of its interest so that the sales pressure is reduced here. Thanks to the high growth and acceptable valuation Alibaba remains a strong stock.
Last year founder Jack Ma stepped down as CEO of China’s largest e-commerce company. At that time, the plan was also implemented to have a listing on the Hong Kong stock exchange. This year is dominated by the corona crisis and tensions between the United States and China. In American political circles, the idea of banning Chinese tech giants such as Alibaba from Wall Street is still alive and well. With a stock market value of almost $600 billion, Alibaba is the largest Chinese company on the New York Stock Exchange and therefore one of the most targeted. The listing in Hong Kong is not a luxury.
Private investors ran wild for the shares offered at 176 Hong Kong dollars. It was Hong Kong’s most important IPO of the decade, worth over $11 billion. The IPO also gave the new top executive Daniel Zhang the means to keep Alibaba on the growth path.
Coronacrisis' positive impact on Alibaba
Alibaba is growing into the sales platform of China. It confirms this every year on Singles’ Day on 11 November, the most important online shopping day in China, resulting in a dizzying growth in sales and profits. Turnover has grown by 68.2, 72.4, 52.1, 45.1, 32.7, 56.5, 58.1, and 50.6 percent respectively since the 2011-2012 financial year (31/3 closing date in each case).
Analysts and investors were looking forward to the impact of COVID-19 on Alibaba’s growth. Asia’s largest market capitalization at the end of May presented the annual figures for the financial year 2019-2020. In the last quarter, which shows the impact of the coronavirus outbreak in China, the Chinese Internet giant saw sales growth drop to 22 percent. For the full financial year, there was an increase of 35 percent: from 377 to 509.7 billion yuan or 71.98 billion dollars. In the three previous financial years, growth was still more than 50 percent. This slowdown in growth was inevitable, especially given the covid-19 outbreak. Online purchases of clothing, the most important category at Alibaba, fell sharply.
At the end of March, Alibaba had 846 million active mobile users, 125 million more than a year earlier. The evolution of the corporate cash flow (EBITDA) was slightly less impressive with a 29 percent increase last fiscal year to 157.66 billion yuan or $12.91 billion. Profits came to 55.93 yuan or 7.90 dollars per share, an increase of 38 percent. The development of net profit in the last quarter was held back by losses on investments in other quoted companies.
One of the new, successful activities is the development of cloud services, for which Alibaba recently announced 5,000 additional recruitments. The Chinese cloud market held 46.4 percent at the end of last year, compared to 18 percent for the number two, Tencent.
The growth of Alibaba is impressive. Prospects remain favorable, but the growth path will become less solid. Based on an expected price/earnings ratio of 26 and an expected ratio of enterprise value (EV) to operating cash flow (EBITDA) of 18, the share is not cheap. But Alibaba continues to grow in an above-average rhythm. In the midst of corona hysteria, the share held up well, thanks to its strongest financial position (USD 35 billion net cash position).
At Tencent, sales growth slowed to 21% in the second quarter. However, the delay was mainly due to the activities with lower margins. The games, still with the largest share of sales, experienced strong growth and thanks to the launch of new titles, the prospects are excellent. Thanks to WeChat, Tencent has • data from more than one billion users. With artificial intelligence, users are approached more and more efficiently (targeted advertisements). Tencent focuses on healthcare, among other things. We-Chat users have access to more than 38,000 medical institutions. E-commerce is not included in the core activities, but that is compensated by the interests in JD.com, Pindupduo and in Singapore’s SEA.