Tencent Earnings: Broad-Based Strength With Emerging AI Upside

Key Morningstar Metrics for Tencent Holdings

• Fair Value Estimate: $102
• Morningstar Rating: ★★★★
• Morningstar Economic Moat Rating: Wide
• Morningstar Uncertainty Rating: High

What We Thought of Tencent Holdings’s Earnings

Tencent TCEHY shares rose 6% in US trading after the company reported second-quarter earnings that surpassed consensus estimates. Revenue increased 15% year over year, while adjusted operating profit climbed 18%.

Why it matters: Tencent’s revenue strength was broad-based, but we think the standout was a 20% increase in advertising revenue, achieved without raising ad load, thanks largely to the company’s effective use of artificial intelligence.

• We see significant potential for Tencent to further leverage its suite of AI tools to enhance engagement and monetization on WeChat. With multiple AI levers in place, we believe Tencent is well-positioned to generate strong returns on its GPU investments.
• In light of these developments, we raise advertising revenue forecasts for Tencent by an average of 6% over the next five years. Alongside our recent upgrade of Tencent Music and other adjustments, we are increasing our recurring operating profit forecast by 7% over the same period.

The bottom line: We raise our fair value estimate for wide-moat Tencent by 13% to HKD 800, reflecting both upward revisions to our forecasts and the increased market value of the company’s listed investments. Our revised valuation implies a 30 times earnings multiple for 2025.

• With Tencent shares currently trading at just 22 times earnings, we see the stock as undervalued. While the market appears to have priced in higher AI-related capital expenditures, it has yet to fully appreciate the long-term return potential of these investments.

Between the lines: On the macroeconomic front, Tencent is seeing improving trends in China, as evidenced by a narrowing decline in average transaction size on WeChat Pay. Management attributes this positive shift in part to the Chinese government’s anti-evolution initiatives.