The Power of Home Court Advantage
U.S.-China Senior Level Talks Resume in Washington
Portfolio Changes:
Tencent (TCEHY) Moves From Hold to Sell
Luckin Coffee (LK) Moves From Buy a Half to Hold a Half
Today marks the first face-to-face talks between senior officials from America and China since July.
It looks like China is offering a truce deal whereby it commits to sizable agricultural purchases in return for no additional tariffs.
This is a far cry from what the U.S. was seeking not long ago and does not solve the key issue: how American firms and workers can profit by selling into the rising Chinese consumer class.
The White House is also looking at rolling out a previously agreed-to currency pact as part of a preliminary deal that could result in next week’s planned tariff increase being suspended, according to Bloomberg.
But the situation, scope and stakes have grown significantly since July, with the protests in Hong Kong, the idea of limiting Chinese companies’ access to U.S. capital markets, and other sensitive issues thrown into the mix.
If the primary goal is to sell more stuff to China, looking at Amazon’s experience might be helpful.
In July, Amazon closed down its Chinese domestic e-commerce business, meaning it won’t compete with massive e-commerce giants from China such as Alibaba and JD.com.
Amazon still plans to let Chinese customers shop at its international websites, including the company’s American, British, German and Japanese marketplaces.
Amazon quietly entered China in the early 2000s full of optimism, but in the end it couldn’t compete with rivals that offered low-cost (or often free) shipping, without requiring users to meet any minimum orders.
So Chinese consumers, often spoiled by having sellers swallow shipping costs and offer overnight delivery to the same province, chose free shipping and overnight delivery offered by domestic companies like Alibaba’s Tmall and Taobao.
The result is that Amazon.cn holds just a 6% share of the Chinese e-commerce market, according to Nomura Securities.
eBay similarly failed in China after investing hundreds of millions into domestic services in the country. After three years of trying, eBay sold its China operations in 2006. Walmart merged its Chinese operations into JD.com, and other titans such as Google and Facebook have gone nowhere in China despite investing substantial amounts of capital and time.
All this underscores the power of home court advantage that American firms face, not only in China, but in many countries around the world.
It also further underscores the importance of having some international companies in your investment portfolio.
Home court company advantages are many, including logistical costs and barriers to entry, support from the home government, cultural barriers, and regulations that impact areas such as staffing and finance.
This brings us back to Alibaba’s edge.
As of the end of June, BABA had roughly 730 million annually active buyers across its Chinese marketplaces—more than double America’s population.
Much of the future growth in the Chinese middle class will come from the regional and rural sectors of China, so having a nation-wide delivery and logistics network to service these markets will be extremely important.
While Alibaba has a penetration rate of more than 85% in the urban centers of China, it is only 40% in rural communities.
This is a great opportunity for BABA and perhaps for America, if Alibaba can eventually serve as a bridge to increase the sales of U.S. firms in China. But it won’t happen if the trade war worsens.
Tencent (TCEHY) Moves from Hold to Sell
I’m moving Tencent from a hold to a sell based on a loss of momentum and because Alibaba and Sea Limited are better plays (one conservative, one aggressive) on Asia’s gaming and e-commerce opportunities.
After vaulting from a share price of 12 to begin the year to as high as 37, SE has pulled back to around 28 over the last two months.
We currently have SE rated as a hold and had previously advised selling half your shares to take some profits off the table.
One of the key drivers of Sea Limited (SE) is its Garena gaming group, which is expected to grow 160% this year. The company will also soon launch Call of Duty: Mobile.
SE has a license agreement with Tencent to sell its games in Southeast Asia.
The second driver is its Shopee e-commerce platform, which some analysts believe could grow revenue 7x to reach $2 billion in 2021.
In addition to this robust revenue growth, Sea Limited has been successfully raising its commission fees. For example, Shopee Mall Thailand has increased seller commissions for non-electronic goods to 5% from 3% and for electronic goods to 3% from 1%.
Thus, SE appears to be in a good spot.
Portfolio Updates
Alibaba (BABA) shares have been choppy in the mid-160s but this stock represents the best near- and long-term quality play on the rise of China’s consumer class. It dominates China e-commerce and its stock is valued attractively at about 10 times expected 2020 earnings.
BABA’s goal is to build out from its current 730 million annual active users to over 1 billion users by the end of fiscal 2024. The company’s e-commerce business lends itself well to a natural monopoly as Alibaba has better than a 50% market share. Alibaba’s cloud infrastructure business also benefits from its scale and lower costs.
BABA can get back to the 200 level and beyond provided that trade tensions ease. I encourage you to buy a full position in this stock if you have not already done so.
BUY.
DBS Bank (DBSDY) shares advanced marginally this week. DBS is a high-quality conservative play on Singapore and Southeast Asia financial services.
It is the largest and strongest bank in Southeast Asia and the leading consumer bank in both Hong Kong and Singapore. Its tentacles reach out through 200 branches in 50 cities. DBS produces steady profit margins, revenue, and earnings and is also increasing market share in consumer and corporate banking.
Despite all of these strengths, DBS is trading at only 11 times trailing earnings and comes with a 4.8% dividend yield. I encourage you to buy at these levels since any tangible improvements in the U.S.-China relationship should get this stock moving.
BUY A HALF.
Huya (HUYA), our most recent recommendation, is China’s leading e-sports platform and game-streaming brand and is rapidly expanding into other emerging markets.
Huya has a large, open pathway to grow beyond China in emerging markets. This is important since 72% of frequent e-sports viewers live outside of the U.S. and Europe and the company is expanding aggressively in Asia-Pacific and Lain America with the logistical support of Tencent.
Its latest quarter featured monthly users growing 57% year-over-year to reach 144 million and revenue growth of 94%. In addition, gross margins improved slightly and sales and marketing expenses are only 6% of revenue.
HUYA stock is now trading at just over 23 and could break out around its March 2019 high of 30. This is an aggressive, high-growth China idea so I advise putting in place a 20% trailing stop loss and starting with a half position. BUY A HALF.
ICICI Bank (IBN) shares moved a bit more in the right direction following a recent surge resulting from India’s tax cut aimed at igniting more growth in India’s economy.
IBN is a solid India play and there are still 191 million Indians without a bank account, which means a lot of potential new customers. This is a good entry point to take a stake in IBN if you have not yet done so. HOLD A HALF.
Luckin Coffee (LK) shares are sitting just above our 18 entry price so I’m moving this stock to a Hold pending some sort of up trend.
Despite its breakneck pace of opening new stores and stands, its CFO has publicly stated it plans to be at breakeven by the end of next year. Its second quarter had high sales and marketing expenses, which can be dialed back in the future.
Luckin believes there is room for more than Starbucks in a market of 300 million-plus middle class consumers. Its strategy to compete with Starbucks is a combination of quality, convenience and affordability with a price target of 50% of Starbucks. Most of its shops are set up for takeaway and delivery rather than the Starbucks model of a place to meet and work.
Luckin keeps expanding its fleet of stores, which grew 375% annually to 2,963 locations and it plans to eclipse Starbucks with 4,500 stores by the end of the year.
Keep in mind that Luckin is an aggressive stock that has only one quarter of operations under its belt since its IPO earlier this year. MOVE FROM BUY A HALF TO HOLD A HALF.
Marvell Technology Group (MRVL), a player in 5G in what is known as smart devices, hasn’t done much since being added to the portfolio three weeks ago.
Smart devices are the name for all the web-enabled devices that collect, send and act on data using sensors, processors and other hardware to talk to each other.
The Marvell team has created a franchise that is a powerhouse in Storage Networking, embedded processing, security and encryption.
The company’s embedded processors and products are cutting edge and already generating multibillion-dollar annual sales. Marvell is headquartered in Bermuda with operations in the U.S., China, Taiwan, Japan, India, South Korea, Vietnam and several other countries.
New markets are emerging in which Marvell has a first-mover advantage, including virtual reality, drones, data integration and consumer and industrial robotics.
I have high expectations for this stock and encourage you to start with a half position if you have not yet done so. BUY A HALF.
Rakuten (RKUNY) shares made a nice move early in the week before giving it back. Prior to that, shares were up nicely for the second week in a row despite a six-month delay for the launch of its wireless network.
Rakuten is a well-diversified conglomerate with tentacles throughout Japan and with plenty of running room for international expansion. Its loyalty membership program is more than 100 million strong and it is Japan’s #1 Internet bank, #1 credit card and one of the country’s leading travel platforms.
Rakuten is the seventh-most visited website in Japan with 490 million visitors in September, with an average length of visit of over six minutes.
The company’s core business is as an internet sales platform akin to Amazon’s. Its market share in Japan is about 25%.
And the stock is trading at just 10 times trailing earnings, booked a 16% increase in revenue during its latest quarter, and offers an impressive 19% return on equity. If you haven’t yet bought shares, this would be a good time to buy a half position. BUY A HALF.
Sea Limited (SE) shares, after beginning 2019 at 12, have pulled back from a high of 37 to around 28 over the last two months.
We currently have SEA rated as a Hold and had previously advised selling half your shares to take some profits off the table.
One of the key drivers of Sea Limited (SE) is its Garena gaming group, which is estimated to grow 160% in 2019. The company will also soon launch Call of Duty: Mobile. Sea has a license agreement with Tencent to sell its games in Southeast Asia.
The second driver is its Shopee ecommerce platform, which some analysts believe could grow revenue 7x to reach $2 billion in 2021.
In addition to robust revenue growth, Sea has been successfully raising its commission fees. For example, Shopee Mall Thailand has increased seller commissions for non-electronic goods to 5% from 3% and for electronic goods to 3% from 1%.
We need to wait for some sort of uptrend to develop before moving SE to a buy.
HOLD A HALF.
Tencent (TCEHY) shares continue to underperform.
I’m moving it from a hold to a Sell based on a loss of momentum and because Alibaba and Sea are better plays on Asia’s gaming and e-commerce industries.
Based on its recent (under)performance, I’m selling. MOVE FROM A HOLD TO A SELL.
Yandex (YNDX) shares gained ground this week in a tough market and were recently picked up for research coverage this week by Alfa Bank with an outperform rating and a price target of 48, implying 34% upside.
The company is incorporated and based in the Netherlands but its core business is the online search.
Yandex, trading at just eight times forward earnings estimates, is overlooked by even sophisticated investors and even then, is primarily viewed as only a search engine play that has cornered 57% of the Russian market.
It is expected to announce third-quarter earnings on October 25. BUY A HALF.
ZTO Express (ZTO) shares were flat again this week after getting a double-digit bump from its positive second-quarter earnings results.
Based in Shanghai, ZTO is one of the largest express delivery companies, not just in China but globally. It offers services to millions of traditional merchants, e-commerce sites, and online sellers using a proprietary tracking system, a state-of-the-art transportation management system, and more than 5,000 trucks, as well as hundreds of business partners.
And ZTO serves foreign customers through partnerships with many international express delivery companies.
I’m keeping this a hold for now but we may need to move on if an uptrend does not develop fairly soon. HOLD A HALF.
