Our Views on Sectors:
China Internet Sector:
We believe the trade dispute between China and the US will continue to be a lingering factor in 2019, subsequently impacting China macro economy and the internet sector. With a substantial decline of over 25% in 2018 and an apparent nosedive since the trade war broke out, we believe the market should have largely reflected the worst-case scenario for China Internet sector. We don’t think, however, internet sector will have a significant turnaround in the near term, given that business confidence remains weak and continued investments are required by many large internet companies. We expect the sentiment of China internet sector to see a gradual recovery in 19H2 as investors could become more rational and pay closer attention to the long-term fundamentals of companies.
Our top picks in internet sector are Tencent and BABA, as Tencent’s gaming business is counter-cyclical and its advertising business will outpace industry. BABA’s core marketplace business would remain stable and strong, driven by growth in lower tier cities and improvement in technology. We are also positive on EDU, as we believe it will take market share amid the tightening K12 AST market. For some of the companies in our coverage, such as JD, Meituan and CTRP, topline growth will remain on a decelerating trend in 2019, but bottom line could see an upside potential, given that spending becomes more restrained in the backdrop of a slowing economy.
Online Advertising Sector:
We anticipate growth of online advertising to follow a “Nike” shape in 2019. High base in 1H18, pessimistic consumption outlook for full-year 2019 and tightened regulations on gaming and internet finance sectors will lead to slower advertising growth in 1H19. However, in 2H19, we expect advertisers to regain confidence and online ad spending growth could accelerate, driven by stronger consumer spending in second half of 2019, as a result of tax reduction, loose monetary policy and potential tentative deregulation (e.g., real estate).
Supply-side upgrade could be also a tailwind to online advertising sector. Per our survey, ad agencies are holding consensus view to allocate more ad spending in video format in 2019, given that video as an ad format results in better ad performance. In addition, the adoption of AI-optimized pricing models (e.g., oCPC and oCPA) will also entice advertisers to spend more on targeted marketing online.
In the context of macro uncertainties, we believe advertisers/merchants are inclined to allocate more advertising budget to those eCommerce channels that can generate sales and achieve decent ROI. BABA is the major beneficiary under this trend, given that its commitment in data technology and new retail to help merchant in economic downturn.
We expect the trend of a segmented China eCommerce market will be maintained in 2019. GMV mix of BABA and JD will continue to shift towards quality and branded products, while PDD would carry on expanding its market share via its low-end product offerings.
Traffic cost has become pricier in the post-internet era, as a result we believe eCommerce players will continue to closely work with social media and content providers, such as Weixin and Xiaohongshu, to acquire new traffic. We believe social eCommerce will continue to thrive in 2019.
Online Game Sector:
We expect supply-side reform will be the main theme of China online game sector in 2019. Policy on game approvals and adoption of 5G technology will drive online game companies to explore and develop new game engines, new play modes and new stories. With the adoption of 3D sensing camera, innovative human-camera interaction features will be introduced to mainstream mobile games. We expect large game companies will start to test high definition AR games powered by 5G in 2H19.
The growth of online game sector will normalize in 2019 thanks to restart of online game approvals. Tencent and NetEase are our top picks, considering their rich experience in R&D and operation. Hot titles in the pipeline, such as Fortnite and Diablo Mobile, will solidify their dominant positions in the market. In addition, we also expect indie and innovative game studios invested or sponsored by Tencent and NetEase (e.g., Tencent A.C.E Program), to publish phenomenal games in 2019.
We expect mobile payment operators to reduce subsidy to merchant service providers (MSPs) in 2019. The aggressive MSP subsidies over the past three years have driven mobile payment penetration to over 50% in 2018, according to our estimates. Consequently, mobile payment companies, primarily Alipay and Weixin Pay, become less reliant on MSPs to acquire merchant customers.
We expect online lending to recover in 2H19, thanks to license registration and re-leveraging in the household sector. We believe the first batch of P2P licenses will be issued in 2H19 after the completion of the latest round of checks on P2P platforms that started in Aug 2018. Some soft comments on shadow banking made by Yi Gang, head of PBOC, last month also showed positive signal on P2P regulation going forward. In addition, loose monetary policy and tentative deregulation on real estate will lead to re-leveraging in the household sector.
K12 After-school Tutoring Sector:
Regulation on K12 after-school tutoring sector will continue to be tightened in 2019. Campaign to relieve the study burden from students will carry on in 2019. As a result, many small-to-medium sized tutorial service providers will continue to be squeezed out from the market. However, education spending is counter-cyclical. Demand from students (or parents) for better or customized tutorial services remains solid and has been difficult to suppress given that the exam-based education system has not changed fundamentally. Large K12 AST companies, such as TAL and EDU, will continue to consolidate the market.
Additionally, online K12 AST will continue to be an important battle field for AST players. We believe TAL is in a better position in online K12 AST market in terms of technology and teaching quality. However, effectively rolling out its online initiative to students nationwide continues to be an uphill task for TAL.
Our Views on Public Companies:
$0700.HK (Tencent Holding Ltd)
We are positive on Tencent as its financial performance will be resilient in a macro downturn. Online games revenue will rebound in 2019 thanks to the restart of online game approvals. Hot PC and mobile titles in the pipeline, including Fortnite, JX 3 and DnF Mobile, will support the growth of gaming business. Apart from regaining the ability to monetize, Tencent will continue the investment and sponsorship on innovative games in 2019 to drive growth for the long run.
Online advertising will outpace industry in 2019. We expect the advertisers will keep moving ad budget toward social platforms. Adoption of video format will be another driver boosting Tencent’s advertising revenue.
Payment related business may turn profitable in 2019. The reduction in MSP subsidies as well as adoption of Mini Fund will decrease the cost of payment and offset revenue loss on interest income respectively.
Digital contents will continue solid growth, driven by paying ratio increase on video, music and reading services.
BABA remains our top pick in eCommerce space for 2019. Despite a slowdown in macro environment, we believe BABA’s core marketplace business would remain stable and strong, driven by growth in lower tier cities and improvement in technology. We expect the company would start to monetize recommendation feeds in 2019, but in a conservative way, releasing incremental ad inventory with better customer engagement.
In addition, we expect the Company to harvest its cloud business in 2019, which should generate profits on an annual basis. Its dominant position in cloud industry offers BABA an advantageous setup in the industrial economy.
Lastly, the Company would continue to invest aggressively in new retail including Hema, Ele.me and Cainiao, which may further pressure its overall margin but generates growth opportunities on a longer horizon. We expect, Hema, in particular, to open another 50-100 stores in 2019 to fuel its nationwide expansion.
2019 will be another challenging year for JD as the company is facing competition in multi fronts, in our view. We expect its topline growth to be slower, negatively affected by a halt in user growth and weakening consumption trend in electronics. However, it may exhibit upside in margin expansion as its services business including ads and logistics continues ramping up with R&D investment beginning to stabilize. Still, we see BABA’s aggressive investment in logistics help it narrow the gap with JD in user experience, and thus create uncertainties on JD’s growth potential over longer term.
We think PDD is an investment target for investors with high risk tolerance. The company would continue its rapid growth in 2019, driven by mass market demand for low-end products. The macro slowdown may create opportunities for PDD, as consumers may become more price-conscious vs. prior. However, as an early stage company, we remain skeptical over the growth of the company on a longer horizon, particularly considering its current market cap of ~$25 bln. Competition with Taobao and difficulty for PDD to attract mid to high-tier brands might affect its monetization and GMV growth from time to time in 2019.
We hold a conservative perspective for VIPS in 2019. The partnership with JD and Tencent would generate limited synergies for VIPS as the company needs to fight for social traffic within Weixin and have difficulties to retain users from JD. We expect its revenue to further decelerate, and its margin may finally stabilize given the company slows down its investment pace. We think its competitive advantage which is inventory clearance for apparel merchants, however, is diminishing in longer term, as PDD starts to gain attention from merchants as a new clearance channel for mid-end branded products.
$1810.HK (Xiaomi Corporation)
We maintain our positive view on Xiaomi for its strong position on smartphone and IoT. Its strategy of offering product with attractive price-performance ratio should work well even if consumption sees slower growth.
Smartphone business will continue robust growth thanks to overseas expansion and increase of high-end model shipments. Strong brand awareness through years of market development will be Xiaomi’s core competencies in India and Indonesia, the two promising smartphone markets worldwide. In China, we believe successful upgrade of product mix in 2018 will be extended in 2019.
We appreciate Xiaomi’s integrated and comprehensive product offerings in IoT. The IoT growth would be driven by expansion into new categories and market share expansion for existing products such as smart TV and electronics.
For internet services segment, after delivering stellar growth rates in 2018, we expect the growth will decelerate to 30-40s Y/Y in 2019, mainly dragged down by stagnant domestic MIUI user base. Upside potential for internet service revenue would be the increase in ARPU and overseas monetization.
$3690.HK (Meituan Dianping)
We are cautiously optimistic on Meituan at this stage, given its share price has retreated more than 30% in the past two months, mostly due to slower growth guidance and increasing competition from BABA. We understand that the competition with Ele.me has casted some uncertainty on Meituan’s growth prospect and profitability. However, we remain confident in Meituan’s fundamentals, given the proven track record of Meituan’s mgmt. team. We also think Meituan’s huge and loyal user base offers Meituan an unparalleled advantage in the local service sector. In addition, current Street expectation has been reset to a more realistic level after Meituan’s communication with the investors. Meituan’s recent measure to deemphasize loss-making initiative is a proper move in a slowing economy. We expect Meituan will continue to narrow loss in 2019, coupled with a decent topline growth of 50%.
EDU is our top pick in K12 education sector. We believe K12 after-school tutoring sector will continue to face tightening regulation in 2019. In the context of heavily regulated environment, we believe EDU is advantageously positioned in the market given that most of its operations, such as teaching content, teachers’ licenses, business licenses, are largely compliant with government policies. Many smaller AST providers will be swiped out from the market due to a harsh regulatory background. Large K12 service providers, such as EDU, will be the beneficiary as a result.
Financially, we expect FY19 will be a margin pressure year as a result of additional costs and expenses in relation to the tightening regulation. However, we expect the Company will see gradual margin recovery starting from FY20 after the drag from regulation tapers off. Our estimates are above Street expectation, as we think EDU will be resilient despite macro softness. We expect EDU will continue to deliver 25% CAGR topline growth in the next two years, mainly driven by 20% learning center expansion.
We are neutral on TAL at this stage. We think TAL shifting focus from offline to online is a correct strategy in a regulatory headwind, given that offline tutorial services have been facing more challenges amid tightening regulation. We expect revenue of TAL’s offline business Peiyou will only grow at 30% in FY20, a significant deceleration from 50-60s in FY18-19. TAL’s online initiative, namely XRS.com, was rated as the best online tutorial service provider among other players in terms of teaching quality and learning outcome, according to our previous survey. However, we think XRS.com remains too small to move the needle. We estimate that the revenue of XRS.com will contribute 16% of total revenue in FY20, up from 10% in FY19. We think investors should pay more attention to XRS.com in the second half of FY20 when it becomes more significant. The question of whether XRS.com can effectively penetrate into lower tier cities is key to the scalability and sustainability of XRS.com. We currently remain watchful on the ramp-up of XRS.com.
Our view on CTRP is neutral. Travel spending, especially on leisure tours, is discretionary and therefore is highly susceptible to macro uncertainty. Growth for travel booking will continue to decelerate in 2019 and CTRP will inevitably be impacted given that it is the largest OTA in the market. We think its upgraded open platform strategy to cooperate with third-party travel agencies is a good move as it can help CTRP to tap into the offline travel market. Margin performance of CTRP may see upside potential, since market competition has become more rationalized, as Meituan, CTRP’s major competitor, has been in a defensive mode and focused on increasing profitability. CTRP is currently trading at 20x FY19 PE, not compelling as we think the market has already baked in potential downside to the company performance.
We are currently neutral on HTHT. We like HTHT’s business fundamental as we believe HTHT will continue to consolidate hotel industry in the long run given its stronger position than its peers. However, we expect HTHT’s revenue growth will be mainly driven by hotel expansion in 2019, as hotel RevPAR growth (on a same-hotel basis) in 2019 will be only at mid-single digit and is no longer a major growth driver for HTHT. Similar to CTRP as a travel service provider, HTHT will be adversely impacted if macro deteriorates.
The research analysts are primarily responsible for this research report accurately reflect their personal views about any and all of the subject securities or issuers as of the date of the report. No part of their compensation was, is, or will be related to any specific recommendations or views in this research report.
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