This week, China Evergrande Group (EGRN.F 13.16%) became a household name for investors -- and not in a good way. The Chinese real estate giant set off a market panic on Monday on talk that a potential default on its $300 billion in debt could send ripples through the global economy.
By mid-week, those fears subsided somewhat, but China Evergrande is still very much a company on the brink. Investors given a fresh reminder of the risk that comes with buying into Chinese stocks are understandably hesitant about jumping in headfirst after Monday's scare.
China is going through a period of transition, and investors are right to be cautious. But there will almost certainly be a lot of winners who emerge from this uncertainty. Here's why these three Fools are backing NIO (NIO -5.00%), JD.com (JD 0.20%), and Baidu (BIDU -0.56%) as long-term survivors as the plot twists continue out of China.
Image source: Getty Images.
The "Tesla of China" is in a regulatory sweet spot
Lou Whiteman (NIO): Evergrande is the focus today, but it has been a rough year for Chinese stocks in general. First, there was the troubled IPO of Didi Global, which led to talk about which, if any, Chinese companies would be able to list abroad. More recently, there has been a crackdown on sectors, including video game companies and education providers.
What they and Evergrande all have in common is an ongoing, behind-the-scenes battle between the pro-business side of the Chinese Communist Party, a group that wants to see "China Inc." spread globally, and the more restrictive, regulatory side of leadership. My bet is that the eventual compromise will involve picking winners, and Chinese companies that both have the potential to expand internationally but are not tech- or data-heavy and don't impact how Chinese society develops will be the ones with the longest leash to grow.
Electric vehicle (EV) makers appear to be a natural champion for China, and Nio is a likely standout among them. Thanks to its charismatic entrepreneur CEO and lineup of luxury EVs, the company has long been referred to as "the Tesla of China," and at long last, we are beginning to see signs the business is living up to that hype.
Nio delivered 21,896 vehicles in the second quarter, more than double the total from Q2 2020. Although the chip shortage impacting all automakers threatens to slow near-term expansion, Nio's agreement with its manufacturing partner gives it the capacity to eventually produce up to 240,000 units annually.
Nio is not yet profitable, and trading at 12 times sales is not inexpensive. But the company has $7 billion in cash on its balance sheet to ride out whatever blips are on the horizon, and continue its expansion in China and into international markets starting with Norway this fall. And the company has established itself as more of a lifestyle brand than a car maker, offering Nio Clubhouses where customers can drop in to hang out and selling a line of branded accessories, clothing, and food products.
I believe Chinese consumers, like their American counterparts, will favor homegrown brands, assuming those brands can deliver a level of quality and dependability that matches what foreign competitors offer. Nio has the brand, and with perks like a lifetime warranty and free roadside assistance, the company is doing what it can to build loyalty.
China is committed to going electric, and Nio looks like a top choice to be among the domestic winners. The company has the balance sheet to survive any crackdown on corporate debt, and vehicles are a good way for China to extend itself globally without giving away precious domestic data or running afoul of foreign privacy laws. Nio looks like the right company at the right time as China works through its growing pains.
Nio's fleet of vehicles. Image source: Nio.
This e-commerce giant is also a logistics leader
Rich Duprey (JD.com): E-commerce giant JD.com provides a platform for third-party sellers to sell merchandise rather than selling goods itself. The pandemic, though, has hastened the shift of consumer spending to online merchants; just as it is in the U.S., e-commerce in China is intensely competitive, fueling investments in the logistics side of the business.
Earlier this year, it spun off a portion of its ownership stake in JD Logistics, its rapidly growing transportation and warehouse business. Revenue surged 54% over the first half of 2021 from the same period last year, and now its property management unit -- JD Property -- just acquired a controlling stake in China Logistics Property Holding, a Chinese local freight forwarder and global logistics transportation company.
The need for warehouses, transportation assets, and logistics operations is a necessary outgrowth of e-commerce's growth, and it's what separates JD.com from its rivals. Alibaba, for example, relies upon third-party providers, though only those in which it owns a stake.
Efficient order fulfillment is critical. Similar to Amazon.com, JD.com, through its logistics arm, is able to offer next-day and same-day delivery options. It has actually been able to deliver about 90% of its total orders on the same or next day in 2020.
Beyond the competitive nature of e-commerce, the other major concern investors might have about investing in Chinese stocks is Beijing's crackdown on tech stocks. JD.com, though, says one of the primary concerns regulators have is the protection of personal data. Sharing such information is an issue for advertising-driven tech stocks but not for JD, which says it has always protected personal data.
There's always going to be friction between capitalist-oriented companies doing business in a communist country, and Beijing has proven to be arbitrary at times with its decrees. While investors have to weigh the risks associated with putting money into play in China as a result, JD.com is a solid business helping to meet the consumer needs of the country's rising middle class.
With its warehouse, transportation, and logistics operations critical components of its e-commerce business, JD.com is uniquely positioned to grow along with China's economy.
Tech giant Baidu is a deep value stock
Rich Smith (Baidu): Like most companies in China, Baidu stock got whacked by the bad news out of Evergrande. Like most companies in China, Baidu stock also recovered a bit when investors decided the Evergrande news might not be all that bad. And yet, Baidu is not out of the hole yet.
Baidu, you see, has problems of its own. As one of the country's biggest tech conglomerates, it sits squarely in the crosshairs of Chinese regulators as they crack down on tech. "Thanks" to China's crackdown, Baidu stock has shed more than half its market capitalization over the last six to seven months.
But I think that was an overreaction.
Consider: As China's biggest search engine, Baidu boasts an $18.3 billion annual revenue stream and earns massive profit margins on those revenues -- 37.2% over the last 12 months, yielding net income of $6.8 billion. But after its sell-off, the stock sells for only $54.4 billion, or barely $42 billion net of cash.
By my calculations, investors are valuing Baidu stock at just 6.2 times trailing earnings, which seems awfully cheap for a company that's grown both sales and operating income at better than 10%, compounded, over the last five years. Granted, with Baidu continuing to spend heavily ($3.3 billion a year) on research and development of new technologies, Baidu's net income hasn't been able to grow as quickly -- about 6.6% a year. But even that number results in less than a 1.0 price/earnings-to-growth (PEG) ratio on Baidu stock.
Seems to me, investors are valuing Baidu stock like they never expect it to grow again despite the likelihood that Baidu's investments in technologies such as autonomous driving are generally considered growth investments. Seems to me, they're valuing Baidu like the government crackdown on tech won't ever let up, either.
An investment in Baidu now is both a bet on growth and a bet that at some point, the Chinese government will stop shooting itself (and its tech sector) in the foot. That's the moment that an investment in Baidu will pay off.
