Last week, we have only a few economic data releases (CQQQ)(FXI) but they were relevant indicators for our understanding of the macro-environment our Chinese Internet sector had been in for the past month. On Monday evening, Caixin/IHS Markit (INFO) announced that the Caixin Services Purchasing Managers’ Index (‘PMI’), also known as the seasonally adjusted Chinese Services Business Activity Index, eased from 51.3 in September to 51.1 in October.
Dr. Zhengsheng Zhong, Director of Macroeconomic Analysis at CEBM Group revealed the details from the survey:
“1) Demand across the services sector grew at a reduced pace, with the gauge for new business falling to the lowest level since February. The measure for new export business picked up slightly. 2) While the job market expanded at a weaker clip, with the employment gauge falling from the previous month’s recent high, the measure for outstanding business rose further into expansionary territory. This implied a mismatch between labor supply and demand.3) Both gauges for input costs and prices charged by service providers edged down, but they remained in positive territory, reflecting relatively high pressure on costs, including those of workers, raw materials and fuel.4) The measure for business expectations dropped to the lowest point in 15 months, indicating depressed business confidence.”
At above 50, the reading showed that service providers still signaled an upturn in activity, albeit a marginal one. However, it was below the consensus estimate at 52.8 and was the slowest increase in services activity in eight months. While both the manufacturing and services PMIs are important gauges for the economy, the latter might be more pertinent to our gamut of Chinese internet stocks.
A definition for the service sector pointed out retail, which includes our e-commerce companies like Alibaba Group (BABA), JD.com (JD), and Pinduoduo (PDD), as well as recreation/media, which includes Tencent Music Entertainment (TME), Momo (MOMO), YY (YY), Huya (HUYA), and iQIYI (IQ), among others. I had a quick look at the entire holdings list of the Chinese Internet sector representative ETF, the KraneShares CSI China Internet ETF (KWEB) and it seemed all of them belong to the service sector.
“Service sector is that portion of the economy that produces intangible goods. The service sector provides a service, not an actual product that could be held in your hand. Activities in the service sector include retail, banks, hotels, real estate, education, health, social work, computer services, recreation, media, communications, electricity, gas and water supply.”
While the October survey findings were quite bearish, it is important to note that the survey submissions were before the good turn in the trade talks progress. Thus, it is very likely that business confidence should have been vastly improved into November given the positive messaging by both the U.S. and the Chinese governments. Even if there isn’t any signing of the purported ‘Phase One’ trade deal this month, a delay largely blamed on the canceled APEC Summit in Chile, the continued momentum and concerted efforts by the trade officials to maintain the cordial relationship should keep sentiment buoyant.
The “Breakthrough In Major Trade Pact” in this article’s title isn’t meant to describe the potential U.S.-China trade deal. It is referring to the Regional Comprehensive Economic Partnership (RCEP) where a summit aimed at finalizing talks yielded positive outcomes. Southeast Asian nations together with China, Japan, South Korea, India, Australia, and New Zealand concluded ‘text-based negotiations’ for a free trade agreement. While India has chosen to walk away from the RCEP, the trade agreement would still comprise 15 economies representing a combined 29 percent share of the world’s GDP. The leaders of the 15 economies reported significant breakthroughs in the negotiations and a conclusion is expected next year.
“We welcomed the report presented by Ministers on the outcomes of the RCEP negotiations, which commenced in 2013. We noted 15 RCEP Participating Countries have concluded text-based negotiations for all 20 chapters and essentially all their market access issues; and tasked legal scrubbing by them to commence for signing in 2020.” – joint leaders’ statement on the RCEP
CNA’s Jeffrey Wilson believed that the RCEP “will deliver a single and integrated set of trade rules for the Indo-Pacific”, putting “the region on par with North America and Europe, who have had integrated trading arrangements for over two decades.” Most critically, the successful implementation of the RCEP “sends a strong message that regional governments are committed to a cooperative, multilateral, and rules-based economic order,” a stark contrast to the prevailing tendency of stroking trade tensions among countries.
A silver lining could also be found in China’s exports and imports data for October, which fell less than expected in October. According to Reuters, consensus estimates from economists it polled were for October exports to decline 3.9 percent and imports to decline 8.9 percent from last year. China surpassed forecasts with exports declining only 0.9 percent and imports declining only 6.4 percent. Trade balance for October was also a beat at $42.81 billion, higher than the consensus estimate of $40.83 billion.
Chinese President Xi Jinping was the keynote speaker at the opening of the second annual China International Import Expo on Tuesday. He pledged to create a more robust domestic market and a modern government would stimulate China’s opening up to the rest of the world. At the event aimed at promoting foreign companies to do business in China, it was comforting to know that a total of 192 American companies took part in the expo, more than last year.
China’s consumer price index (‘CPI’) for October came in after global markets closed on Friday, too late to have an impact for the week. However, an increase was well within expectations and not a concern for the Chinese central bank. The People’s Bank of China further lowered the borrowing costs on Tuesday to encourage lending. It initiated a small reduction in the interest rate on the medium-term lending facility, a key reference used by banks to price loans, the first cut since the interbank market instrument was introduced in 2016. President Trump would appreciate a similar move in the U.S. to keep the economy humming.
The KWEB ETF closed up 4.19 percent for the week. As explained in a past issue of the Chinese Internet Weekly, I found the KWEB ETF holding the most representative stocks in the sector. As such, an overview of the week’s share price movements of the top few holdings of KWEB as compared with the ETF itself is provided as follows for convenient reference especially for the stocks mentioned in this article. In the subsequent sections, I will elaborate on Baidu’s (BIDU) outstanding share price jump post-results, iQIYI’s technical breakout, and its Q3 2019 results.
Baidu share price skyrocketed post Q3 results
The share price of search engine giant Baidu rose nearly one-fifth last week thanks to estimates-beating Q3 2019 results. Well, at least for revenue and Non-GAAP EPS where it surpassed consensus estimates by $40 million and $0.60 respectively. Its GAAP EPS missed by $3.23 on -$2.57, largely due to a non-cash impairment loss on equity investments that have experienced “an other-than-temporary decline” in valuation.
The revenue beat might not be much for a company with quarterly revenue at $3.93 billion. However, excluding revenue from divested businesses, the revenue from ‘Baidu Core’, essentially stripping the contribution from video-streaming platform iQIYI, increased 8 percent sequentially in the third quarter, on top of the 12 percent sequential growth in the second quarter. An impressive feat for a company deemed to be under severe competitive threat from privately-owned ByteDance (BDNCE) and a challenging advertising landscape. More pleasing to the ears of shareholders was the potential for the revenue growth to play “catch-up” with the much superior traffic growth, as teased by the management during the earnings conference call.
Perhaps, the sentiment change from ‘Very Bullish’ to ‘Very Bearish’ among Seeking Alpha authors is telling. A rebound potentially comes when market players throw in the towel and call it a day on the stock. It happened for Baidu.
Source: Seeking Alpha
Professional analysts aren’t doing much better either. Following a year of downward revisions in price targets, some analysts are backpedaling on their calls. CCB International raised Baidu from Neutral to Outperform with a $130 target while Bernstein was more aggressive with a $139 target, upgrading Baidu from Market Perform to Outperform at the same time.
Although Baidu App is playing second-fiddle to the new generation of apps from developers like ByteDance, it is far from being an after-ran. There were several remarkable metrics achieved by Baidu App during the Q3 2019:
- Daily active users continued to see robust growth, reaching 189 million or up 25 percent year-over-year;
- The share in which the first result satisfied user queries reached 56 percent compared to 40 percent a year ago;
- In-app search queries grew over 25 percent year-over-year;
- Feed time spent rose 16 percent year-over-year;
- Feed plus short video app time spent jumped 35 percent year-over-year.
Daily user time spent on Baidu’s knowledge content in Baidu’s family of apps jumped 41 percent, while daily video views, including Baidu wiki and Baidu experiences, rose 36 percent as compared to June, signaling strong momentum in take-up rate. The numbers are hardly reminiscent of a company unable to adapt in the app world, as many critics have charged.
Baidu’s Smart Mini Program saw monthly active users skyrocketing 157 percent higher year-on-year, hitting 290 million in September, seemingly defying the law of large numbers at this stage. In addition, in the last three months, the number of Smart Mini Programs more than doubled, while user time spent on Baidu’s Smart Mini Programs grew 32 percent.
I highlighted Baidu’s AI Edge in one of the Chinese Internet Weekly in July. Some comments revolved around the apparent lack of proven cases around its AI capabilities. During the Q3 2019 earnings conference call, Robin Li, the CEO and founder of Baidu, cited the official website of China’s largest TV station, CCTV.com, using Baidu Cloud video editing AI solution during the live broadcasting of China’s 70th anniversary celebration on October 1 and achieved a roughly 10 times improvement in its video editing efficiency.
Robin Li also provided many other successful applications of its Baidu Cloud AI solutions which makes the earnings call a worthy read/listen for the full details. It is important to note that the company is not done with its AI development journey. R&D expenses, excluding stock compensation, amounted to CNY3.9 billion, up 18 percent year-over-year. The increase was primarily attributed to larger personnel expenses, particularly for AI development.
iQIYI’s stellar Q3 2019 results helped its shares achieve a technical breakout
Of course, we should not forget that part of the optimism for Baidu came from the improving metrics for iQIYI. The former is the 56.7 percent shareholder of the latter, controlling 92.9 percent of its total voting power. I had earlier raised the concern that Baidu’s diminishing market valuation and standing among the Chinese internet giants could impede iQIYI’s full potential and ability to compete with formidable rivals in the likes of Tencent Video, Kuaishou and ByteDance’s Douyin/TikTok. Baidu is itself encroaching into videos.
For now, iQIYI’s operating metrics suggest it has been doing just fine. iQIYI continued its solid membership growth with subscriber count reaching 105.8 million in September, up 31 percent year-over-year, and a quarterly net addition of 5.3 million. Despite critics’ charge that Chinese consumers are unwilling to pay for services, iQIYI managed to grow its subscription revenue nearly a third at 30 percent year-over-year. In fact, the revenue from subscriptions accounted for more than half of iQIYI’s total quarterly revenues for the first time, shifting the video platform from an advertising-led company into a subscription-led one.
Tim Gong, CEO and founder of iQIYI, revealed during the earnings conference call that the temporary heightened content regulation ahead of the October 1st National Day celebrations have been gradually loosened up. He guided that certain titles that had already been produced but prevented from showing will be “gradually released either towards later of [the] fourth quarter or the beginning of the first quarter of next.” Any approval is a bonus since the upfront costs have been incurred. After all, iQIYI has a solid lineup of programs and would not be crippled by the inability to screen a few productions.
“We have a strong content pipeline heading into the fourth quarter of 2019 and the full year of 2020. Our content reflects our mainstream values and dedication to Chinese culture. Apart from our original drama, Hot-Blooded Youth, and flagship Qipa Talk Season 6 that we already released so far in Q4. Other major titles scheduled for the rest of the year include Sword Dynasty, The Great Master, Fearless, FOURTRY and Qing Yu Nian. Looking ahead into 2020, we have over 200 titles planned for release, including over 100 dramas, 30 variety, 5 vertical short dramas and 90 other titles which range from animation to documentaries. In addition, iQIYI Sports will broadcast UEFA EURO 2020, La Liga, 2022 FIFA World Cup qualification games in Asia, as well as the Australian Open, Wimbledon Championships, WTA PGA Tour and other top sporting tournaments.” – Tim Gong, CEO and founder of iQIYI
Moving from fundamentals to technicals, I noticed belatedly that iQIYI has broken out of its down-sloping resistance convincingly. At the last done price of $19.52, it was trading at less than half its peak in June 2018. Shareholders might be comforted that the stock has a strong support line formation from the bottoms established in late 2018 and early October this year.
Source: ALT Perspective (using Yahoo Finance charting tool)
With the last traded price matching the consensus price target according to YCharts, and the positive momentum in terms of price action as well as positive operational developments, there is potential for subsequent upwards price target revisions to further boost the share price. Bank of China International recently upgraded its recommendation on the company’s ADRs to Buy from Hold, and assigned a price target of $21.
One indicator which is flashing a cautionary signal, however, is the Quant rating on iQIYI. On the five core metrics, it improved on ‘Growth’ and ‘Momentum’. Its score on EPS revisions worsened over the last six-month period while profitability remained unchanged with an ‘F’ grade.
Source: Seeking Alpha Essentials
Another stock that saw a break out was JD.com. While I flagged a potential break out in a penultimate issue of the Chinese Internet Weekly, I did not expect a sustained one to happen that quickly.
“Technically, JD.com‘s share price chart looks interesting. The stock has been on an uptrend since late 2018. However, the ceiling which was around the share price level before the plunge in early September has served as a very strong resistance. Nevertheless, the movements have resulted in a bullish formation known in technical analysis as an “ascending triangle”. It is possible that traders use positive news coming out of the Singles’ Day to play up the stock, and when confirmed with the quarterly results, there could be sustained fundamental support for a breakout reminiscent of early 2017.” – ALT Perspective, Oct. 28, 2019
Source: ALT Perspective (using Yahoo Finance charting tool)
I hope that shareholders have good fundamental reasoning buying into the stocks resulting in the breakouts. I do not wish this is happening only because the market is driven by ‘Extreme Greed’ as the meter provided by CNN Money is indicating.
Source: CNN Money
Disclosure: I am/we are long BABA, BIDU, TCEHY, NTES, JD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.