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China technology sector stock outlook for 2023

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It has been one other rough yr for China’s tech stocks. Billions have been wiped off the worth of the country’s web giants including Alibaba and Tencent and corporations have posted their slowest growth rates on record.

A Covid resurgence in China, which the federal government countered with its strict “zero-Covid” policy of swift and harsh lockdowns in major cities, has hurt the world’s second-largest economy. Chinese web firms have seen a slowdown as consumer spending was hit and promoting dollars were reduce.

Investors are treading with caution into next yr with regard to Chinese tech stocks and analysts are broadly expecting regulation to be more predictable and growth to speed up. But uncertainty around China’s economic outlook is creating risks.

Still, signs that China might be fascinated with opening its economy again have given investors hope of a turnaround.

“We’re positive on 2023 web sector outlook in light of reopening story and improving consumer sentiment,” analysts at investment bank Jefferies said in a research note last month.

Zero-Covid rest in focus

For the reason that outbreak of the pandemic in 2020, China has adopted the so-called zero-Covid policy which attempts to make use of strict lockdowns and mass testing to manage the virus outbreak. But that policy has weighed on the economy and brought a toll on businesses.

Web giants Tencent and Alibaba posted their slowest revenue growth rates on record in 2022, while electric vehicle makers like Xpeng saw lackluster sales as consumer sentiment took a success.

But there are signs that China’s Covid policy could also be reversing.

China eases Covid restrictions on travel within the country

This month, Chinese Vice Premier Sun Chunlan said the Omicron variant of the coronavirus is less severe than previous versions, a shift in tone from the federal government ahead of announcements on relaxing Covid control measures.

On Dec. 7, Chinese authorities formalized a slew of easing measures which included allowing some people infected with Covid to isolate at home slightly than at government facilities, and removing the necessity for a virus test for those travelling across the country.

In my opinion, the largest challenge faced by tech firms next yr might be still COVID and, consequently, the weak and unsure economic outlook.

Xin Sun

King’s College London

How the exit from zero-Covid is handled could ultimately determine the extent of the rebound for China tech.

“I’ll argue the prospect of a tech rebound next yr depends totally on the extent to which macroeconomy and particularly consumption could get better,” Xin Sun, senior lecturer in Chinese and East Asian business at King’s College London, told CNBC via email.

“Given the present extremely suppressed level of consumption, largely on account of COVID restrictions and likewise the shortage of confidence amongst consumers, a tech rebound is indeed likely if China could easily exit from zero-COVID and reopen the economy.”

Tech growth rates set to speed up

Analysts broadly see growth for Chinese tech names reaccelerating in 2023 because the Chinese economy prepares to reopen — but growth won’t likely be on levels seen prior to now, where quarterly revenue jumped 30% to 40%.

Alibaba is forecast to see a 2% year-on-year jump in revenue within the fourth quarter of this yr, before accelerating to simply over 6% within the March quarter of 2023 and 12% within the June quarter, based on analysts’ consensus estimates from Refinitiv.

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Tencent, meanwhile, is anticipated to post year-on-year revenue growth of just 0.5% within the December quarter followed by 7% in the primary quarter of 2023 and 10.5% within the second quarter, based on Refinitiv.

Jefferies said in a note that it considers “online shopping as being in a sweet spot to embrace the recovery story before promoting and entertainment.” That may benefit firms like e-commerce giant Alibaba and rival JD.com.

Analysts on the investment bank said they expect internet advertising industry growth to rebound in 2023 but warned that growth can be “highly depending on macro environment.”

Regulation becomes more predictable

China’s strict Covid policy was a significant headwind for its tech sector this yr, but investors were already spooked since late 2020 when Beijing ramped up regulatory tightening.

The regulatory crackdown has been a giant think about giants posting slower growth rates and has hammered their stocks.

For the reason that start of 2021, the Hang Seng tech index in Hong Kong, which incorporates most of China’s tech giants, has fallen greater than 50%.

Over the past two years, Beijing has introduced a spread of policies from latest antiturst rules to data protection laws and an unprecedented law governing the usage of algorithms by tech firms.

Why China's cracking down on tech — and what's next

Firms that fell foul of antitrust rules were punished with large fines, including Alibaba and food delivery company Meituan, as Beijing moved to reign in the ability of its web giants which had, until recently, grown largely unencumbered.

The gaming sector has been badly hit. In 2021, regulators froze approvals for the discharge of latest video games and brought in rules that capped the period of time kids under the age of 18 could play online.

The principles spooked investors who were largely caught unaware by China’s regulatory assault on its tech sector.

Nonetheless, there are signs that among the regulatory pressure could also be easing. Regulators restarted the approval of games this yr, which can profit Tencent and NetEase, China’s two biggest online gaming firms. The federal government has also on multiple occasions this yr pledged to support the technology sector.

“Beijing’s top priority this yr is economic growth. The crackdown-style governance is over because Beijing has recognized that it’s a foul idea to spook markets and undermine business confidence,” Linghao Bao, analyst at Trivium China, told CNBC.

“We have already seen some recent attempts to chill out Covid measures and rescue the property markets. That said, regulations can be here to remain. Meaning the main target has shifted toward a more measured, predictable approach to regulating big tech.”

Changing business models

From diversification to selling off stakes in other businesses, the impact of regulation and a slowing economy is changing the way in which Chinese technology giants are running their firms.

Firstly, Chinese tech firms have been cutting costs and exiting non-core businesses so as to boost profitability.

Along with running China’s hottest messaging service WeChat, Tencent can also be a prolific investor in other firms.

But the corporate has recently began divesting stakes in a few of China’s biggest firms. As scrutiny on the tech sector increased, Tencent sold off stakes in some investees including JD.com and Meituan.

Tencent can also be specializing in other areas including it fledgling cloud computing business and a global push as gaming sales, one among its biggest drivers of revenue, stays under pressure.

I’m more bullish than I used to be 6 months ago just because I feel the costs have fallen much further than future earnings estimates have needed to be revised downward.

Tariq Dennison

GFM Asset Management

Alibaba, whose China retail business makes up the majority of its revenue, is attempting to ramp up sales from areas similar to cloud computing to diversify its business.

Beijing has also looked to separate some financially-linked businesses related to tech firms.

Ant Group, the fintech affiliate of Alibaba, was ordered in 2021 by China’s central bank to turn out to be a financial holding company after its initial public offering was pulled in November 2020. Tencent said earlier this yr that it’s exploring whether regulations would require its WeChat Pay mobile payments service to also fall under a separate financial holding company.

“The crackdowns have fundamentally modified the business logic these firms must follow … prior to now Chinese tech giants strived to construct the so-called ‘ecosystem’, which, by aggressively acquiring and integrating different lines of business, increased customer stickiness and engagement,” said Sun from King’s College.

“Now they need to reduce to give attention to their important business lines and seek revenue growth from optimised operation and innovation.”

Biggest risks

While some investors have reasons to be optimistic about China’s tech industry next yr, they’re definitely treading with caution.

Uncertainty in regards to the path of China’s exit from its zero-Covid policy and the trajectory of the economy in 2023. Several investment banks have cut their China economic growth forecasts over the past few months amid a slump in exports and a drag from the actual estate sector, two essential drivers of growth on the planet’s second-largest economy.

“In my opinion, the largest challenge faced by tech firms next yr might be still COVID and, consequently, the weak and unsure economic outlook,” Sun said.

Tariq Dennison, wealth manager at Hong Kong-based GFM Asset Management, told CNBC there are also quite a lot of geopolitical risks including American investors being blocked from buying Chinese tech stocks to firms being nationalized.

Nonetheless, he clarified that these risks are present but unlikely.

“I do not think lots of those scenarios are that likely,” he said, adding that geopolitical risks are the “biggest collective threat.”

What it means for Chinese tech stocks

Plenty of analysts and investors told CNBC over the previous couple of months that the plunge in Chinese technology stocks has left a few of them looking “low-cost” or undervalued.

That is because stock prices have fallen faster than what analysts consider might be the earnings potential for a few of these Chinese technology firms.

“I’m more bullish than I used to be 6 months ago just because I feel the costs have fallen much further than future earnings estimates have needed to be revised downward,” Dennison said.

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One metric analysts take a look at is forward price-to-earnings, a measure of an organization’s earnings relative to its stock price, expressed as a ratio. A high P/E could indicate that a stock’s price is comparatively high in comparison with its earnings, and possibly overvalued.

“The typical valuation of China web names … is 14x 2023 P/E vs 22x of world peers as of 30 Nov,” Jefferies said. “We expect the market to look beyond the 2022 turmoil and revisit the sector in 2023.”

Indeed, analysts still see significant upside for Chinese tech stocks.

On average, analysts have a price goal of $134.40 on Alibaba’s U.S.-listed shares, indicating roughly 54% upside from the Monday close of $87.16. Analysts have a median price goal of 386.91 Hong Kong dollars on Tencent’s stock, or about 20% upside from the Monday close of HK$320.40.

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