Tencent's (TCEHY 5.23%) stock recently rallied after the Chinese tech giant posted its third-quarter earnings. Its revenue rose 29% year-over-year to 125.45 billion yuan ($18.4 billion), beating estimates by 1.65 billion yuan and matching its growth rate in the second quarter.
Its net profit surged 89% to 38.54 billion yuan ($5.7 billion), topping expectations by 8.2 billion yuan. On an adjusted basis, which excludes its investment-related gains and other one-time items, Tencent's net profit rose 32% to 32.3 billion yuan ($4.7 billion).
Those are impressive growth rates for a 22-year-old company, but some investors might be reluctant to chase a stock that has rallied 85% over the past 12 months. However, I believe Tencent's stock still has room to run, for five simple reasons.
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1. The explosive growth of its gaming business
Tencent's online gaming revenue surged 45% year-over-year, marking an acceleration from its 40% growth in the second quarter, and accounted for a third of its top line.
Tencent attributed its growth to the popularity of Peacekeeper Elite and Honor of Kings in China, as well as licensed games like PUBG Mobile and Call of Duty Mobile in overseas markets. It also owns League of Legends publisher Riot Games and nearly half of Fortnite publisher Epic Games.
Tencent's gaming growth accelerated through the COVID-19 pandemic as more people stayed at home, and maintained that momentum even after the lockdowns ended. The segment's gross margin also expanded year-over-year as it generated more revenue from higher-margin first-party games instead of licensed ones.
2. The expansion of its social media ecosystem
Tencent's WeChat (known as Weixin in China) ended the quarter with 1.21 billion monthly active users (MAUs), up 5% from a year ago. This monolithic platform continues to expand with millions of Mini Programs, which let users make payments, order products, hail rides, and access other services without ever leaving the app.
Tencent also owns the older messaging platform QQ, which still hosts 617 million mobile MAUs, the streaming media platforms Tencent Video and Tencent Music, the e-sports streaming platforms Huya and DouYu, and other smaller apps. It also operates smaller social video games within those platforms.
Tencent's total social networking revenue from all those apps, which include subscriptions and in-app purchases but exclude digital ads, rose 29% year-over-year and accounted for 23% of its top line.
3. Robust sales of online ads
Many of China's top online advertising platforms struggled over the past year as macro headwinds throttled ad purchases. However, Tencent's online ad business, which scatters ads all across its sprawling ecosystem, continues to outperform the broader industry.
Image source: Getty images.
Tencent's ad revenue rose 16% year-over-year, accelerating from its 13% growth in the second quarter, and accounted for 17% of its top line. By comparison, online advertising revenue at Baidu, China's top search engine, has fallen year-over-year for six straight quarters.
Tencent attributed its ad growth to robust demand from the online education, internet services, and e-commerce sectors, as well as rebounding demand from the pandemic-stricken real estate and auto sectors. Robust ad sales on Weixin also offset a slight decline in its ad sales from media platforms like Tencent Music and Tencent Video.
The accelerating growth of Tencent's ad business indicates it's pulling companies away from older platforms like Baidu, and that trend could continue for the foreseeable future. As an added bonus, an industrywide exemption from China's "cultural construction" fee this year lifted the ad segment's gross margin year-over-year.
4. Its fintech business is still growing
Tencent's fintech and business services revenue -- which mainly comes from Tenpay/WeChat Pay, its various fintech services, and Tencent Cloud -- rose 24% year-over-year and accounted for 27% of its top line.
That marked a slowdown from its 30% growth in the second quarter, partly due to a "softer" quarter for Tencent Cloud. Tencent Cloud previously ranked second in China's cloud infrastructure market behind Alibaba Cloud, but Canalys' latest figures indicate it's dropped to third place behind Huawei Cloud.
That slowdown was disappointing, but it was partly offset by the growth of WeChat Pay and its wealth management services. The segment's gross margin also held steady year-over-year, indicating it wasn't sacrificing its margins to gain ground against Alibaba's cloud platform and its fintech affiliate Ant Group.
5. It's still reasonably valued
Analysts expect Tencent's revenue and adjusted earnings to rise 36% and 44%, respectively, this year. Based on that forecast, Tencent's stock trades at 38 times this year's earnings.
That valuation is cheap relative to its growth. Some recent concerns, including potential actions against Tencent in the U.S. and new antitrust rules in China, could be temporarily depressing its valuation.
But over the long term, I'm confident Tencent will overcome those challenges. I personally started accumulating shares of Tencent back in early 2017, and I still believe it's a great time to add more shares of this resilient growth stock.
