Tencent's stock price fell after its performance report, but Wall Street collectively raised its target price! Why?

Yesterday, TENCENT, which released its first-quarter results slightly later, did not receive a market surprise response.

On Thursday, May 18th, TENCENT's Hong Kong stock opened low and fell nearly 4% at one point, eventually closing down nearly 1%, with the stock price falling below HKD 340.

Obviously, although TENCENT's quarterly revenue returned to double-digit growth after a year and a half, and its core gaming business achieved success both domestically and overseas, investors seem to be more concerned about one unexpected data point - the adjusted net profit for the quarter was CNY 32.54 billion, CNY 700 million less than the market expected.

Should we be worried? Wall Street says: no need to worry! We still like TENCENT and even collectively raised our target price!

Why not worry about profits?

Morgan Stanley was the first to point out that TENCENT's net profit data this time was lukewarm, mainly because a one-time tax adjustment caused distortion - the effective tax rate for the first quarter of 2023 was 30%, compared to 10% in 2022.

Domestic brokerage Debon Securities further explained that TENCENT's higher-than-average income tax expenses for the quarter masked the actual unexpected profit elasticity:

The final net profit attributable to shareholders for this quarter was slightly lower than expected, and is expected to have been significantly affected by income tax - the apparent income tax rate on the income statement was 30%.

After adding back "net other income" and "net profit attributable to associates and joint ventures" to the pre-tax profit and calculating the income tax rate, the level of 31% is still significantly higher than the average of the previous eight quarters of 19%.

Even if we simply assume that the income tax expense will be reduced by nearly CNY 2.6 billion by using the higher 24% relative average level in the first quarter of 2022, the net profit attributable to shareholders calculated on a NON-IFRS basis will be CNY 35.1 billion, a year-on-year increase of 38%, and the actual profit growth is very strong.

From another perspective, revenue for the quarter increased by 11% year-on-year, gross profit increased by 19% year-on-year, while sales, management, and research and development expenses decreased by a total of 9%, and the sum of the above four items increased by 63% year-on-year. The cost reduction and efficiency improvement on the revenue side under the recovery has shown unexpected elasticity on the profit side.

Why are we collectively optimistic about TENCENT?

Morgan Stanley said it is currently more confident about the group's profit prospects. Surprisingly, due to the structural transformation of revenue and continued cost benefits, the profit margin structure continues to improve.

The report stated that TENCENT's first-quarter adjusted operating surplus exceeded the bank's expectations by 19%; the growth rate of adjusted earnings per share increased from 19% in the fourth quarter of last year to 28% in the first quarter of this year. The bank expects that its growth will further accelerate for the rest of this year, reaching 30%.

Supported by strong momentum in the domestic and international markets, TENCENT's online gaming revenue growth has accelerated to 11% year-on-year in the first quarter of this year, and the bank expects this strong momentum to continue. For the domestic market, the strong total revenue in the first quarter of this year may support game revenue for the next few quarters.

As a result, the bank has raised TENCENT's target price by 2% to HKD 440 from HKD 430. Based on the latest closing price, this means there is still a 29% upside potential!

In addition to JPMorgan, Citigroup, Goldman Sachs, and Jefferies have also raised their target prices for TENCENT, citing "solid first-quarter performance and better-than-expected results":

Citigroup raised TENCENT's target price from HKD 503 to HKD 506, implying a 49% upside potential;

Goldman Sachs raised TENCENT's target price from HKD 442 to HKD 443, implying a 30% upside potential;

Jefferies raised TENCENT's target price from HKD 465 to HKD 470, implying a 38% upside potential.