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Better Buy: Tencent Holdings or JD.com?

By Leo Sun - Sep 15, 2018 at 11:00AM

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Which beaten-down Chinese tech stock is the better long-term play?

It's been a rough year for Tencent ( TCEHY 1.02% ), one of the biggest tech companies in China, and for JD.com ( JD 0.26% ), the country's second largest e-commerce player. Tencent is JD.com's biggest investor, and JD.com integrates its shopping ecosystem into Tencent's WeChat, the top mobile messaging app in China.

Shares of Tencent tumbled more than 20% this year due to a slowdown in its gaming business, which was exacerbated by tougher government regulations. JD.com shares dropped 35% due to concerns about its widening losses and sexual assault allegations against its CEO. Escalating trade tensions between the US and China also weighed down both stocks.

The Beijing skyline.

Image source: Getty Images.

Contrarian investors may be wondering if either stock can rebound over the next few quarters. Let's take a closer look at both companies to find out.

Which company is growing faster?

Tencent owns a wide range of businesses, including WeChat, the older QQ messaging platform, the Qzone social network, the WeChat Pay payments platform, a massive portfolio of video games, video and music streaming services, and a cloud services platform.

Tencent's revenue rose 56% last year, and analysts expect 37% growth this year. Depite a gradual slowdown of its online gaming business (34% of its sales last quarter), higher ad revenues across its expanding WeChat ecosystem, a rising number of paid subscribers for its streaming services, and the growth of its payment and cloud service units should continue to generate top line growth.

However, there are concerns that the Chinese government's plans to curb gaming addiction by reducing the number of game approvals could cause Tencent's gaming sales to dry up. New high-growth mobile apps, like ByteDance's Jinri Toutiao, could also pull users away from WeChat, which currently reaches over a billion monthly active users.

A group of young adults take a selfie.

Image source: Getty Images.

JD.com owns a business-to-consumer (B2C) marketplace that competes directly against Alibaba's ( BABA -0.37% ) Tmall. JD takes ownership of most of the products sold on its marketplace and completes those deliveries with its first-party logistics services. Alibaba mostly relies on third-party logistics services, which generate lower revenues but higher profits.

JD's revenue rose 40% last year, and analysts expect 30% growth this year. JD only controls about 16% of China's e-commerce market, compared to Alibaba's 58% share, but it's supported by a growing web of allies and investors -- including Tencent, Walmart, and Alphabet's Google.

These companies are all pooling their data and sharing their platforms with JD to counter Alibaba in the e-commerce and cloud markets. To continue growing, JD plans to expand into more Tier 3 to Tier 5 cities across China, invest more heavily in growth markets like food deliveries, and tether more brick-and-mortar stores to its online ecosystem. However, it's still unclear if the recent allegations against CEO Richard Liu will hurt the brand's reputation.

Spending money to make money

Tencent and JD's revenue growth looks solid, but earnings growth is a different story. Both companies are heavily investing in the expansion of their ecosystems.

Tencent is expanding WeChat's platform with "mini programs" (in-app apps), investing in a long list of high-growth companies (including Fortnite publisher Epic Games, PUBG maker Bluehole, and even Tesla Motors), as well as cloud and AI technologies.

Those investments are causing its earnings growth to decelerate, exacerbated by a slowdown in its online gaming revenues. Tencent's non-GAAP earnings surged 43% last year, but analyst expect just 12% growth on the same basis this year. That's not an impressive growth rate for a stock that trades at about 37 times this year's earnings.

A JD.com delivery robot.

A JD.com delivery robot. Image source: JD.

JD has repeatedly invested in the expansion of its logistics network, which includes human couriers, warehouse robots, and delivery robots and drones. Over the long term, these investments should pay off as they streamline JD's fulfillment services. However, those expenses are preventing the company from reporting consistent profits.

JD's non-GAAP net income rose 140% to 5 billion RMB ($0.8 billion) in 2017, but that figure was inflated by the spin-off of its fintech unit JD Finance, and it remained unprofitable on a GAAP basis. JD's non-GAAP earnings are expected to decline 14% this year due to the aforementioned expenses -- which is also a weak growth rate for a stock that trades at over 60 times this year's earnings.

The winner: Tencent

I personally own shares of Tencent and JD, and I'm seeing a paper profit on the former and a loss on the latter. I'd add a few more shares of Tencent at these prices, but JD faces too many unanswered questions about its CEO and its capital-heavy business model to be a compelling buy.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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Stocks Mentioned

Tencent Holdings Limited Stock Quote
Tencent Holdings Limited
TCEHY
$60.34 (1.02%) $0.61
JD.com, Inc. Stock Quote
JD.com, Inc.
JD
$78.29 (0.26%) $0.20
Alibaba Group Holding Limited Stock Quote
Alibaba Group Holding Limited
BABA
$125.08 (-0.37%) $0.46

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