3 Most Undervalued Chinese Stocks

Hardly anyone can disagree with the fact that the Chinese stock market is not a place for the faint of heart. Over the past couple of years, it has witnessed almost everything, from a scandal with the falsification of reports by several large companies to the tightening of the regulatory constraints in multiple sectors.

Does is it mean that one should stay away from the Chinese market? According to Morningstar, quite the contrary - the recent sell-off may have created a historic investing opportunity for long-term allocators. It is also worth mentioning that the Chinese market regularly provides investors with an opportunity to buy in at significantly lower levels.

To be more precise, over the past 17 years, the MSCI China index has experienced five drawdowns in excess of >30% in US dollar terms. These include: fears of a hard landing in 2004 (30% decline), the Global Financial Crisis in 2008 (74% decline), the Renminbi crash and A-share boom-bust in 2015 (35% decline), trade war and de-leveraging concerns in 2018 (32% decline), and the latest regulatory concerns (33% decline). Nevertheless, the index has returned an astonishing 500% since the beginning of 2004.

Currently, the MSCI China index is trading at over 60% discount to the S&P 500 on a price-to-book basis, which is one of the widest levels in the past five years. The question then arises, which companies are worth looking at? Analysts from Morningstar believe that despite the regulatory risks, Tencent Holdings Ltd (TCEHY), JD.com Inc (JD), Alibaba Group Holding Ltd (BABA), Yum China Holdings Inc (YUMC), DiDi Global Inc (DIDI), NetEase Inc (NTES), Las Vegas Sands Corp (LVS) and Wynn Resorts Ltd (WYNN) traded on U.S. exchanges are in “deeply undervalued territory”.

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But is it really the case?

Let’s take a look at these following three tickers: BABA, BIDU and NTES.

Alibaba (BABA)

During the first fiscal quarter of 2022, the online retailer's revenue grew by 33.8% YoY to 67,7 billion RMB, and net income per share - by 12% YoY to 16.6 RMB. At the same time, adjusted EBITDA decreased by 4.7% YoY to RMB 48.6 billion.

One of the key drivers of revenue growth is the development of Chinese e-commerce as the economy recovers and the country's online retail turnover grows. In addition, the company announced an increase in its share repurchases from $10 billion to $15 billion.

That's all well and good, but what about the outlook? The fact that the company continues to invest in business development is grasping: just yesterday, there was news that the Chinese IT giant has invested more than $300 million in DeepRoute.ai, a self-driving technology startup. Furthermore, Alibaba has invested in another autonomous car startup, AutoX, and is also backing electric vehicle maker Xpeng. The question remains: will these investments pay off?

Baidu (BIDU)

In the case of Baidu, the IT giant increased its revenue in April-June 2021 by 20% - to 31.35 billion yuan (US$4.86 billion) from 26 billion yuan in the same period a year earlier. The growth was driven by increasing ad sales and climbing demand for its AI-powered cloud products.

Looking ahead, Baidu expects its revenues to slow down by 8-19% in the third quarter of 2021, reaching a range of 30.6 billion yuan (US$4.7 billion) to 33.5 billion yuan (US$5.2 billion). Assuming that most of the negative news is already embedded in Baidu's quotes, the stock looks quite attractive at its current price.

NetEase (NTES)

According to unaudited financial results for the second quarter, net revenues were RMB20.5 billion (US$3.2 billion), an increase of 12.9% compared to Q2 2020. Gross profit was RMB11.2 billion (US$1.7 billion), an increase of 14.3% compared to Q2 2020. Total operating expenses were RMB7.4 billion (US$1.2 billion), an increase of 32.2% compared to the Q2 2020.

For the outlook, NetEase expects to continue expanding by introducing more content from different cultures around the world and start to work on other game formats, including console games and mobile versions as we look to tap into these large market opportunities in China and abroad. On top of that, NetEase remained bullish in the face of the latest policy changes as less than 1% of its revenue comes from minors.

Final thoughts

Needless to say, there is no certainty that the stock market will behave exactly as one expects. Remember, the greater the risk, the higher the potential for profit or loss. One of the biggest risks for the Chinese stock market would be the default of Evergrande. Considering the fact that the company's liabilities represent approximately 2% of the Asian country's GDP, the bankruptcy of Evergrande would not only mean the destruction of millions of direct and indirect jobs but a real economic catastrophe. Thus, in the case the “contagion effect” blows up, the majority of the Chinese stocks will also be considerably impacted.