Tencent & Cisco – Chinese spanner

China throws a spanner in the works of both Tencent and Cisco.

Tencent Q1 2022

• Tencent reported weak results as growth evaporated leaving the company waiting for both the end of Covid-zero and the regulatory crackdown before it can see growth once again.
• Q1 2022 revenues / net income were RMB135.5bn / RMB23.4bn behind estimates of RMB141.5bn / RMB26.4bn.
• This represents flat revenue and much lower net income compared to last year and the outlook looks pretty difficult.
• The message from the company is that the easing of the regulatory crackdown is going to take a long time to impact the company which is completely at odds with the statements from the government which appears to want to get this over with as quickly as possible.
• This implies that there is more regulation to come for Tencent but other companies like Meituan or Alibaba, who have already felt the icy touch of the regulator, will recover more quickly.
• This makes sense because its financial services business remains untouched while the business of its competitor, Ant Group, has been decimated by the state (see here).
• That being said all Chinese technology companies face the zero Covid headwind which China is showing no signs of giving up on.
• This is causing havoc both in global supply chains and with the domestic economy and it is not until China realises that it has to live with Covid like everyone else that the economy will recover.
• Hence, I think that the outlook for Tencent remains difficult with a regulatory overhang that others have already emerged from.
• Hence, I continue to prefer Alibaba which is both cheaper and has already emerged from regulatory troubles.

Cisco FQ3 2022 – The canary

• Cisco reported bad results blaming the supply chain & Russia, but it is clear that demand is also softening as a result of the now persistent inflation and weak macro environment.
• FQ3 2022 revenues / adj-EPS were $12.5bn / $0.87 behind forecasts of $12.3bn / $0.86.
• This represents a revenue miss of $500m of which $300m was blamed on supply shortage leaving the exit from Russia and softening demand to make up the rest.
• Guidance was also soft with FQ4 22 revenues now expected to decline YoY and growth in the order book slowing down.
• One quarter ago, Cisco reported 30% YoY growth in orders, but this has now slowed to 8% YoY.
• Cisco is a turns-based business meaning that it fills orders fairly quickly after receiving them unlike most of its competitors who work on long-term contracts.
• Hence if there is a change in demand, then Cisco will typically see it first and this will send a shiver through the sector.
• Cisco was down around 20% in after-hours trading which is likely to be felt by the rest of the sector when it opens for trading today.
• This is a worrying sign for the equipment sector, but Cisco was adamant that most of it is due to supply chain so when this eases, things are expected to improve.
• Nokia remains my preferred stock in this sector which is underpinned by a turnaround story as well as the opportunity to take market share from Huawei as it exits certain markets.
• This story is very much intact, but a slower top-line may mean that it takes a little longer for the full results of the turnaround to be felt in the earnings.
• I am still happy to sit on Nokia where I am looking for around €6 per share.