China Tech – Looking into 2021
Timothy Fung, Head of Equity Advisory, Asia
With it's exceptionally outstanding performance in January, China tech stocks could be near-term overbought technically and a short-term mild consolidation would not be surprising.
China tech stocks recorded one of the best months in their history during January 2021, as abundant market liquidity, especially from the Southbound Stock Connect, chased after the high growth tech stocks. Strong tech initial public offering (IPO) pipeline and the return of American depository receipts (ADRs) further added oil to the fire.
With this exceptionally outstanding performance, we believe the market could be near-term overbought technically, with Hang Seng Tech Index trading at more than 40x forward P/E now. Profit-taking pressure has also started to accumulate. We would not be surprised to witness a short-term mild consolidation in China tech stocks.
Going into 2021, however, we maintain our medium/long-term constructive view on China tech sector given the robust economic recovery, domestic consumption focus in the country’s “dual circulation” strategy, and lasting online migration of entertainment, retail sales and local services. Our sub-sector views are as follows:
Ecommerce: Antitrust impact should be manageable. E-groceries is a key area of growth.
Mobile games: Another year of growth supported by strong game pipeline and global expansion.
Online social entertainment: Greater competition for user traffic and time spent; user traffic growth is expected to slow down and the platforms are anticipated to focus on improving monetisation during 2020-2025E.
Online travel agents: Eyeing outbound recovery, with efficiency enhancement bringing margin upside.
Advertising: Expecting meaningful recovery as the overall economy improves, with short-video platforms continuing to take wallet share due to their fast-growing user base and high return on investment (ROI).
In terms of risk factor, the US government has purportedly scrapped plans to place select Chinese tech firms on the sanction list, for fear of roiling the markets. Should there be a U-turn on this decision, there could be a sharp but temporary downward reaction to the share price. Regulatory overhang is likely to remain in the near term, but it should offer entry opportunities. We believe risk has been largely priced in and expect manageable revenue impact on the sector as a whole.
We reduced our exposure to select tech, airline and cement stocks as their recent announcements suggest a delayed recovery, while re-entering select handset supplier on share weakness. We also increased weighting on the healthcare sector as a defensive laggard.
In 2020, China tech companies have significantly outperformed the Hang Seng Tech Index by 78.7% (on a pro-forma basis). This strength has extended into 2021, when China tech stocks recorded one of the best months in their history during January 2021, as abundant market liquidity, especially from the Southbound Stock Connect, chased after the high growth tech stocks. Strong tech IPO pipeline and the return of ADRs further added oil to the fire.
Going into 2021, we maintain our constructive view on China tech sector given the robust economic recovery, domestic consumption focus in the country’s “dual circulation” strategy, and lasting online migration of entertainment, retail sales and local services.
Regulatory overhang is likely to remain in the near term, but it should offer entry opportunities. We believe risk has been largely priced in and expect manageable revenue impact on the sector as a whole. Fintech may be the most impacted but other segments’ profitability could benefit from orderly competition and reduced subsidies.
Industry leaders may likely lag in 1H21 due to antitrust regulations but will likely rebound in 2H21 when regulations stabilise. We expect second liners to continue to outperform in 1H21 as they benefit from strong business momentum and less regulatory risk.
Meanwhile, the US government has purportedly scrapped plans to place select Chinese tech firms on the sanction list according to Wall Street Journal in an article on 5 January 2021, for fear of roiling the markets. Should there be a U-turn on this decision, we expect there to be a sharp but temporary downward reaction to the share price, and we would likely adjust our target prices for the select firms downwards by 10-15% to cater for higher risk premium.
Ecommerce: Antitrust impact should be manageable. E-groceries is a key area of growth
Heading into 2021, we expect China’s ecommerce retail sales to grow in the high teens (vs. +18% in 2020). Online fast moving consumer goods (FMCG) and fresh groceries will be the major driver of growth in gross merchandise value (GMV) for ecommerce in 2021, given:
(i) favorable user behavior change driven by COVID-19, while online penetration is still very low at 3.8% in 2019; and
(ii) leading ecommerce platforms will aggressively expand into the fresh grocery categories, suggesting significant upside potential for online penetration to improve.
Overall, we expect leading ecommerce players to continue taking market share from other smaller players, backed by their stronger capacity for promotions and marketing, better supply chain and user traffic.
There has been some criticism on community group-buying grocery business recently. For instance, on 11 December 2020, the People's Daily made some comments on community group-buying and encouraged internet giants to put more attention on innovation and technology, rather than seemingly over focusing on the daily grocery business.
Given the criticism, leading players may stay somewhat low-key on this business in the near term. However, given the importance of this business in a longer term, we still believe the online fresh products and fast moving consumer goods (FMCG) business will be the key ecommerce investment area and a growth driver.
CHART 1. CHINA’S ECOMMERCE GMV
Source: Morgan Stanley estimates, December 2020. Past performance is not indicative of current or future performance
Mobile Games: Still a year of growth in 2021 supported by strong game pipeline and global expansion
After the spike in 2020, we expect online games market revenue growth to normalise in 2021, but to remain more resilient than feared given stronger game pipelines. China game revenue grew 17% in 2020 (31% for mobile), which we expect to decelerate to approximately 10% (15% for mobile) in 2021. In terms of margins, we think spending on sales and marketing will become more rational in 2021, thus the negative operating leverage trend in 2020 is unlikely to be repeated in 2021.
Industry giants’ game pipelines are stronger than a year ago, and many of them have a global audience. There have been waves of top consoles and personal computer franchises being converted to mobile games in recent years and we expect this trend to continue. Many titles have potential to generate annual revenue of RMB10 billion or more.
Globalisation of mobile games remains as a long-term secular trend - the overseas revenue earned by the Chinese publishers reached USD3.9 billion in 3Q20 which was equivalent to 40% of China's domestic market revenue, and we expect the mix to continue to rise.
CHART 2. CHINA’s MOBILE GAMES OVERSEAS REVENUE
Source: Huatai estimates, January 2021. Past performance is not indicative of current or future performance
Online Social Entertainment: Greater competition for user traffic and time spent
2020 marked an extraordinary year for the online entertainment names, due to the traffic surge brought by the pandemic during 1H20. We saw polarised performance among peers. Short video platforms now account for 45% of total social entertainment revenue and continue to take a higher share in the traffic pool and users’ attention span.
As the user penetration rates of short video and live streaming platforms have already reached high levels, we expect user traffic growth to slow down and the platforms to focus on improving monetisation during 2020-2025E. We expect there will be increased competition for incremental traffic. Leading platforms will focus on developing a comprehensive entertainment ecosystem to explore monetisation opportunities and enhance the lifetime value of their users.
CHART 3: CHINA'S ONLINE ENTERTAINMENT MARKET REVENUE MIX
Source: Huatai estimates, January 2021 Past performance is not indicative of current or future performance.
Online Travel Agents: Eyeing outbound recovery
The travel industry has been one of the hardest hit by the COVID-19 outbreak. Domestic travel demand has shown meaningful improvement thanks to effective pandemic containment in China, yet cross-border travel is still at a minimal level. On the other hand, online travel agencies have also benefitted from accelerated online adoption during the pandemic.
By the end of 3Q20, the booking volume for domestic travel products for leading OTA (online travel agents) platforms largely recovered to the same level as last year, outpacing the overall industry. Despite the slowing momentum in the recent winter, we see the recovery trend continuing in year 2021, underpinned by distribution and administration of COVID vaccine.
On competition, given the weakness on cross-border travel, the domestic market will be the main battlefield. We believe competition will intensify in 2021 but will remain rational. First, the leading players have further reinforced their leadership and dominant positions in the online travel market as smaller agents were less capable to weather the storm. This should lead to a more consolidated market and stable industry landscape. Second, given one of the leading online group buying platform’s strategic focus on the community group purchase business which is expected to take up substantial resources, we see the hotel business to be of a lower priority in the near term.
On earnings, travel names should see recovery growth in 2021 and efficiency enhancement measures this year should also bring margin upside when demand fully recovers.
Advertising – Room to rerate
Online advertising suffered from the lockdown due to COVID-19 in 1H20 but rebounded soon in 2H20 as economic activities returned to normal. However, there was divergence of advertisement platforms in the recovery, with short-video platforms continued to take wallet share due to their fast-growing user base and high ROI. Looking into 2021, we expect the demand of advertisers to see meaningful recovery as the overall economy improves.
CHART 4: CHINA'S ONLINE ADVERTISING MARKET REVENUE MIX
Source: Huatai Estimates, as at January 2021. Past performance is not indicative of current or future performance
With the exceptionally outstanding performance year-to-date, China tech stocks could be near-term overbought technically, with Hang Seng Tech Index trading at more than 40x forward P/E. Profit-taking pressure also starts to accumulate. We would not be surprised to witness a short-term mild consolidation in China tech stocks, and would take it as a good long-term re-entry opportunity.