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Is the Chinese internet sector oversold? Some analysts seem to think so

Felicia Tan
Felicia Tan • 4 min read
Is the Chinese internet sector oversold? Some analysts seem to think so
UOB Kay Hian has kept "market weight" on the sector albeit with lower target prices on the companies under its coverage.
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The month of July was a particularly bad one for Hong Kong’s Hang Seng Index (HSI) due to the Chinese government’s crackdown on in-house technological firms and educational firms.

Chinese tech stocks in Hong Kong were among the hardest hit in the recent sell-off, which sent the HSI in a tailspin over two days.

UOB Kay Hian analysts Julia Pan and Oong Chun Sung view the correction on the China internet sector as “overdone” following the increased focus on variable interest entity (VIE) structured foreign listed entities by Chinese regulators.

Keeping their “market weight” recommendation on the sector, Pan and Oong write that the sector could still rely on alternative funding sources such as bond raising instead of through equities.

That said, Pan and Oong’s recommendation stands given that “regulatory headwinds will persist”.

To them, valuation for the Internet sector will remain under pressure due to the increasing concerns on data security and foreign ownership.

“Hence, we do not recommend bottom fishing at this point in time until the regulatory risks subside,” they write in a July 27 report.

Pan and Oong have lowered their target price estimate on Alibaba to US$247 from US$308, and their estimate for JD.com to US$86 from US$92. They have also lowered their target price estimate on Tencent to HK$580 from HK$760.

See also: UOB Kay Hian, DBS Group Research up target prices as iFAST Corp posts record AUA again

They have also downgraded Meituan, Kingsoft and Weimob to “hold” with target prices of HK$253 (from HK$360), HK$37 (from HK$59) and HK$10 (from HK$15) respectively.

In addition, the analysts have downgraded Pinduoduo to “sell” with a lower target price of US$85 from US$113 previously.

To Morningstar Equity Research analyst Chelsey Tam, the market fears on the Chinese internet sector appear to be an overreaction.

However, Tam views the market outlook as “uncertain” if there is further tightening in other businesses in Tencent and internet companies.

“Netease's cloud music should be a beneficiary, which is already well understood by the market, in our view,” she writes in a July 26 report.

Tam has not changed her fair value estimates for Chinese internet firms due to their intact fundamentals.

To her, a “severe clampdown and material fair value destruction is unlikely at this stage, given the government’s support of the platform economy and the strategic importance of the sector”.

“But we believe investors could stay away from the sector until regulation risk subsides,” she adds.

Tam, in a later report on July 27, adds that she has kept her estimates on Chinese internet counters despite the country’s announcement by the Ministry of Industry and Information Technology that there would be a half-year rectification on internet companies, signalling further regulatory tightening.

“We don’t see any material concrete impact from this at this stage,” she says.

Tam has kept her four-star rating on Tencent, which means that an appreciation beyond a fair risk-adjusted return is likely.

Technical analysis

Looking at past market patterns, the decline of the market cap on the HSI over the past week follows the decline on May 31, 2020, says PhillipCapital analyst Chua Wei Ren.

Whether the low seen on July 26 will mimic the recovery that was seen on June 15, 2020, remains to be seen, he says.

For more stories about where the money flows, click here for our Capital section

On July 28, the HSI closed 1.54% higher, which is something Chua is not ready to celebrate just yet.

“Despite [the] strong volume, the need to clear above key support turned resistance will then remove the threat. Afterall, [a] clear downtrend has been formed and escalated by the Chinese government,” he writes in a July 29 report.

Earlier this year, the HSI weekly chart saw prices breaking new highs after clearing the key psychological resistance level at 30,000.

Chart: PhillipCapital

“As Hang Seng fails to clear above 31,000 psychological resistance level, it forms a bull trap above the bullish AB=CD resistance zone with an evening star formation,” says Chua.

Like the China A50 index, the bearish sell down unfolded in a three-wave corrective pattern… the slight rebound on Wednesday may see the possibility of a continued upside, he adds.

That said, “should [the] Hang Seng Index fail to clear above [the] 26,000 level, which is a buffer level for the bullish hammer, Hang Seng will continue its sell-off to 200% extension level of the head and shoulder formation,” says Chua.

Photo: Bloomberg

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