Category: Investing Analysis

Tencent released its 2022 second-quarter results last week and the headlines sounded pretty dire.

“Tencent woes mount even after US$560b selloff” – The Business Times

“Tencent’s workforce shrinks for first time in nearly a decade” – Bloomberg

“Tencent, the $370 billion Chinese tech giant, posts first ever revenue decline” – CNBC

If you’re just reading these headlines in isolation, you might think that Tencent is in dire straits. But that’s really not the case. On closer inspection, I think there a number of positives to take away from Tencent’s latest results.

Revenue growth will probably return after China’s lockdowns ease

Tencent’s revenue was down 3% to US$20 billion in the second quarter of 2022. This was the first time Tencent reported a decline in revenue but this shouldn’t have been a surprise. Most of Tencent’s revenue is derived in China and in the bulk of the second quarter of 2022, parts of China were still in COVID lockdowns.

There’s a common misconception that as an internet services company, Tencent will not be impacted by lockdowns. But this is far from the truth.
One of Tencent’s biggest revenue and profit drivers is its payments ecosystem, otherwise known as its Fintech segment. This is highly dependent on commercial activity and also includes offline payments. During lockdowns and when China’s economy is weak, this segment of Tencent’s business suffers. Conversely, when the economy reopens, the growth of Tencent’s payment business should start to reaccelerate. 

Tencent also has a huge advertising business. When the economy stalls, advertisers cut back on marketing spending. In the second quarter of 2022, Tencent’s advertising revenue declined by 17%. Again, this should reverse when China’s economy improves.

Margins will get better

Tencent’s operating profit declined 14% during the quarter to US$5.5 billion, excluding exceptional items. Although this may seem alarming on the surface, there are signs that Tencent’s margin will climb in the future.

The company has been actively cutting costs and improving efficiency. In the second quarter of 2022, Tencent’s sales and marketing expenses dropped by around US$300 million. There were other cost-cutting initiatives, such as right-sizing the number of employees, stopping loss-making businesses, outsourcing unprofitable projects, optimising server utilisation, and exercising more prudence with content production in Tencent’s long-form content segment.

All of these cost-saving initiatives should lead to better margins for Tencent from the next quarter onwards.

Management is also confident about its Gaming business

Tencent’s revenues from both the domestic and international games segments were flat. The domestic games business was hampered by regulatory restrictions. For international games, the challenge came from the reopening of economies worldwide. 

On the domestic front, the regulatory environment is starting to improve as there has been a resumption of the issuance of licenses for new games. In June this year, it was reported that China had issued 60 licenses to new titles, which is positive news for game developers such as Tencent.

In addition, Tencent’s current gaming franchises still have highly-engaged audiences, with engagement numbers for both domestic and international games being relatively high. 

Tencent’s capabilities in digital gaming gives management confidence that the company is well positioned for growth once the challenging environment laps.

Share buybacks good for shareholders

Besides a likely turnaround in its business, Tencent has been using its capital to buy back shares. I think this is a value-accretive initiative given the fact that Tencent’s shares are relatively cheap compared to the value of its business and the potential free cash flow it could generate.

For perspective, Tencent has a market cap of around US$370 billion now. Its investments in public and private companies are worth around US$150 billion. This means the rest of Tencent’s business has a value of around US$220 billion, which is merely 12 times that of Tencent’s annualised operating profit for the second quarter of 2022. With Tencent’s operating profit likely to improve from here, the stock looks undervalued.

But don’t just take my word for it. Tencent’s own management has said its shares are very undervalued. In the latest earnings conference call, Martin Lau, Tencent’s president, said:

“We are very focused on returning capital to shareholders given we believe our share price is very undervalued and also undervalued in the context of our investment portfolio. So if you look at what we’ve done year-to-date, we’ve returned around $17 billion, $18 billion to Tencent shareholders. And we’ve been largely neutral in terms of our investments, divestments in other companies, excluding the substantial JD divestiture. So our focus from a sort of investments perspective has been buying back and dividending to our own stock, and that will likely remain the case going forward for some period of time. “

Bottom line

Headlines don’t always paint the full picture. In Tencent’s case, while the headlines conveyed a story of a company in dire straits, Tencent’s business is actually in a strong position to return to growth. The operating climate is challenging but Tencent’s core businesses remain in a good position.

Its shares are also priced at a low valuation, giving management the perfect opportunity to buy back shares and reduce its share count. This should be a long-term benefit to patient shareholders. 

Based on today’s valuation, I think patient shareholders who are willing to hold shares for the long-term will likely be well-rewarded in the future.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I currently have a vested interest in Tencent. Holdings are subject to change at any time.

We know that investing in high-growth companies can be very rewarding. But there are more ways to make money than investing in growing companies.

A classic example

A great example of a company that has not grown but has still given shareholders sizeable returns is Vicom .

Vicom is a vehicle inspection company based in Singapore. It is mandated by Singapore laws that all cars in the country have to undergo an inspection either annually or once every few years depending on the age of the car. A majority of the vehicle inspection centres in Singapore are run by Vicom, giving the company close to a 75% market share in the sector.

However, because of its relatively high market share, Vicom has limited opportunities to grow. Moreover, in recent years, the Singapore government has targeted zero vehicle growth on the roads to reduce congestion. This has limited the expansion in the addressable market for vehicle inspection in Singapore.

I also suspect that Vicom’s inspection business is regulated by the government, which limits the company’s ability to increase its prices too aggressively.

Because of these reasons, Vicom’s business has been stable but growth has been non-existent. The table below shows Vicom’s revenue and profit since 2012.

The company’s revenue and profit have barely budged for a decade. Yet shareholders who bought Vicom’s shares in 2012 have made a healthy profit.

A decade ago, the company’s share price was S$1.13. Today, they are norht of S$2. As such, Vicom’s shareholders have enjoyed capital appreciation of 82%. In addition, shareholders have collected a total of S$0.751 per share in dividends, which translates to a 66% yield based on the S$1.13 share price.

What’s the catch?

Shareholders who held on to Vicom’s shares for the past 10 years had earned a total return of 148%. And that’s even excluding any potential returns from reinvested dividends.

So why were shareholders so well-compensated despite Vicom not growing in the past decade?

Firstly, Vicom’s shares were trading at a low price a decade ago. At that price, investors could scoop up shares relatively cheaply and earn a decent return simply by collecting dividends.

Secondly, Vicom’s management decided to reward shareholders by paying a much higher dividend per share over time. Vicom had accumulated large amounts of cash on its balance sheet over the years and had little use for it. You can see this play out over the years as Vicom’s dividend payout ratio rose and exceeded 100% in four of the last five years. Management’s decision to pay shareholders a larger dividend caused Vicom’s share price to appreciate as investors were willing to pay a higher price given the higher dividends.

From this, we can see that when investing in no-growth companies, shareholders need to buy at a low valuation and hope for a rerating in the share price to make a capital gain. Oftentimes, a catalyst needs to occur for the share price to appreciate. In Vicom’s case, an important catalyst was management’s change in stance toward its dividend payout ratio.

If you buy Vicom’s shares today, it is unlikely that its share price will appreciate at the rate it did in the past, given the already high valuation of the shares today and the limited opportunity for further dividend growth given the already-high payout ratio.

What to look out for when investing in no-growth companies

Investing in companies that are not growing can still be rewarding. But it is important to know that not all no-growth companies will perform as Vicom did.

When looking at slow-or-no-growth companies, one of the main things to look out for is a low share price. If a company is trading at an unreasonably low multiple, even if its earnings don’t grow, the share price can still appreciate over time.

Next, when investing in slow-or-no-growth companies, it is important to look at the company’s cash position and dividend payout ratio. A company that has more than sufficient cash on its balance sheet is likely to eventually decide to pay that excess cash out as dividends. This provides shareholders with more dividends and can be a catalyst for a re-rating of the share price.

Third, look for a business that is resilient. Vicom’s business has not grown in a decade, but its revenue has not declined either.

If you invest in a company whose profits are declining, the valuation multiple might compress further and what may seem like a value stock will end up as a value trap. On top of that, if profits are declining, management will probably not increase its dividend payout ratio in a bid to use its cash to reaccelerate growth, oftentimes ineffectively.

Lastly, because dividends are a major source of returns when investing in a slow-or-no-growth company, it is important to find companies that are domiciled in places where there is no withholding tax on dividends. For example, if you’re a Singaporean investor, you should not have to pay tax on your dividends. But if you invest in US stocks, there is a 30% tax. As such, it is best to stay away from such companies in the US.

The bottom line

There are many ways to invest in stocks. Although I prefer to pay a higher multiple to invest in growing companies, other investors may prefer to buy no-or-slow-growth companies at a low multiple and wait for valuation re-ratings and/or to collect dividends.

Whichever method you prefer, the main thing is to find a style that you are comfortable with and suits your investing appetite.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I do not have a vested interest in any stocks mentioned. Holdings are subject to change at any time

There’s been plenty of discussion among market participants and business executives over the past few months on the uncertainties confronting the US economy, and how the businesses from various industries in the country will perform in an uncertain economic environment.

For companies that are focused on providing software and/or digital infrastructure, their businesses may continue to shine regardless of the macroeconomic uncertainties thrown their way. I say this based on comments – see below – shared by the leaders of these companies during their latest earnings conference calls that took place over the past two months. There was no specific reason why these companies were chosen, other than me having a vested interest in them.

Adobe (17 June 2022)

I think the other part of the conversation that you all have with enterprise CEOs right now is they all recognize it’s an uncertain time, and that’s the conversation that we have. But despite that uncertain macroeconomic environment, the thing that all of them recognize is that digital is a priority. And they really want to continue to have conversations with us as to how they can do digital. I’ll have Anil maybe add a little bit of what he’s seeing across different verticals as well. But the importance of digital remains undiminished.

Amazon (29 April 2022)

So yes, I mean, we’re continuing to see what the backlog is, right? It’s the increase of AWS [Amazon Web Services] customers making long-term commitments for AWS. At the March period ended, we had $88.9 billion balance for that. So that’s up about 68% year-over-year. And the weighted average remaining kind of life term for those is 3.8 years.

Datadog (5 May 2022)

We believe that digital and cloud projects are still very high priority and are not being de-prioritized, we haven’t seen that. We think we’re still early on. So, with the data we have so far, we think there will be continued strong investment. There is always some volatility across our customer base. Our customer base is very well diversified across industries and we benefited from that over time. So, whereas we’re not macro forecasters and there may well be some sensitivity, we believe the long-term trends in digital migration and cloud will also be very strong throughout that cycle.

Microsoft (27 April 2022)

The second thing is in the conversations we are having with our customers, the interesting thing I find from perhaps even past challenges, whether macro or micro, is I don’t hear of businesses looking to their IT budgets or digital transformation projects as the place for cuts. If anything, some of these projects are the way they’re going to accelerate their transformation or, for that matter, automation, for example. I have not seen this level of demand for automation technology to improve productivity because in an inflationary environment, the only deflationary force is software. So that’s the second micro thing, the tone thing that’s different.

MongoDB (2 June 2022)

That being said, we understand that there is heightened focus on the macroeconomic outlook because of geopolitical tensions, inflationary pressures and the risks of a slowing global economy. Since macro-related questions are dominating investor conversations, it makes sense to share with you what we are seeing as well as to discuss our framework on how we plan to manage through this macro uncertainty. Starting with what we’re seeing in the market. First quarter was a robust quarter for new business. Driving innovation remains a top priority for our customers, and they’re investing in modern technologies to facilitate this. We had strong engagement with the C-suite, and our deal cycles were in line with normal patterns. The tone of our quarterly business review meetings at the start of the second quarter was that of confidence. Our sales force indicated that our message is resonating in the marketplace, and they remain bullish about the opportunities to win new business.

Salesforce (1 June 2022)

And so far, we’re just not seeing any material impact from the broader economic world that all of you are in. Our demand environment where demand is very strong, and if you look over the last 23 years, Salesforce has proven to be incredibly resilient based on this incredible business model. We have an incredible technology model that we have, where we’ve been through all kinds of dot-com crashes and recessions and financial crises and global pandemics and all of you have watched us go through every possible storm, but we continue to weather these storms through the power and strength of our model.

Veeva Systems (2 June 2022)

This is really a long-term thinking move by the customer. They’re thinking of this in 10- and 20-year horizon, so they wouldn’t be really fazed by specifics of the macro environment. So this is about, yes, applications in the clinical area but also in the quality and the regulatory area, not all of our Development Cloud but a big portion of it. So when they’re doing that, it’s a very top-down decision. It’s like building a huge factory. That’s why it’s not affected by the macro environment. And then if you get it, what they’re trying to do, it’s laying the foundation for efficiency, digital efficiency, getting drugs to market faster to help patients. So it’s a long-term play by the customer and sort of executive-level decision.

Twilio (5 May 2022)

I think, obviously, if like the economy were to dip into like some sort of significant recession, we’re not necessarily immune from that. But what we see based on both our internal studies, and we alluded to the customer engagement report as well as a number of external studies, is that digital transformation remains a top boardroom priority. That obviously benefits Twilio as a variety of companies look to invest in their engagement strategies going forward. And we’re not — it’s not like we don’t see the macro environment, whether it’s economic or geopolitical, but we just think this business is extremely well positioned to capitalize on ongoing companies’ digital transformation efforts.

Zoom Video Communications (24 May 2022)

[Question:] I’m wondering, have you seen any paring back or moderation of investment from some customers in light of growing macro concerns? And if so, has it varied by either geography or customer size?

[Answer:] I mean we really have it — especially in enterprise, we have continued to see strength in renewals as well as additional new customers and expansion into additional products. So we really haven’t seen that in terms of concern. I think we’ve heard from other people that what they’re really focused on might be — if they’re limiting spending, it’s focused more around potentially hiring or travel. And of course, Zoom is a great alternative if they’re focusing on limiting internal travel. And so we really haven’t seen that impact today.

Final thoughts

One underlying theme among the comments seen above is that companies continue to invest in their digital transformations, and they are doing so despite the uncertainties that abound, such as the risk of a recession in the USA. This is a tailwind for businesses that are providing the tools for organisations to embrace the digital world. 

The economic news coming out of the USA has been bleak of late. Only time can tell if technology companies are able to grow their businesses even in the face of a weak economic environment. At the very least, their managers are confident.

It’s worth noting too that there’s at least one precedent of a software company posting admirable growth rates even when the economy was weak. This happened during the Great Financial Crisis of 2008/09, when the USA’s real GDP fell by 4.3% from a peak in the fourth quarter of 2007 to a bottom in the second quarter of 2009. The unemployment rate also rose from 5% in December 2007 to 10% in October 2009. While the US economy was in trouble, Salesforce’s revenue grew by 51% in 2007, 44% in 2008, and 21% in 2009. Salesforce provides customer relationship management software over the cloud and it was able to grow rapidly during the financial crisis because its software was better than incumbent solutions.

If software and digital infrastructure companies today are able to provide better solutions for their customers than what they’re currently using, they could continue to grow even if the economy worsens from here, just like what happened to Salesforce a dozen years ago. But even if they struggle to grow in the near term, the long run picture still looks healthy. According to Microsoft’s CEO Satya Nadella, around 5% of global GDP is currently spent on technology. It’s hard for me to imagine this percentage going down in the years ahead – what do you think?

---

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I have a vested interest in Adobe, Amazon, Datadog, Microsoft, MongoDB, Salesforce, Veeva Systems, Twilio, and Zoom Video Communications. Holdings are subject to change at any time

Warren Buffett once said: “If you’re making a good investment in a security, it shouldn’t bother you if they closed down the stock market for five years.”

With the US stock market in a bear market, these words ring louder than ever. But, I would go even further and suggest that the truly long-term investor shouldn’t bother even if the stock market closed forever. Yes, you heard that right- forever.

Even if we are never able to sell our shares, a truly good investment (bought at the right price) should still pay off over time as companies pay their shareholders dividends.

For example, let’s say you bought shares of the Singapore-listed hospitals owner Parkway Life REIT back in 2007 at its offering price of S$1.28 per share. After you made your investment, the Singapore stock market completely closed down and you were left holding on to your shares with no way to sell them. Since then, you would have collected a total of $1.46 per unit in dividends (technically, a REIT’s dividends are called distributions, but let’s not split hairs here).

Today, even if you are not able to sell your shares, you would still have more than made up for your investment and continue to be entitled to future dividends.

This is the goal of the long-term investor. I do not hope to simply sell off an asset at a higher price to a higher bidder; instead, I’m comfortable holding the asset for its cash flow.

But what if your stock doesn’t pay a dividend now? The same concept should still apply. This is because companies may be in different phases of their life cycle. A growing company may not pay a dividend when it’s growing rapidly. But after some time when excess cash builds up in its coffers over time, it can start paying that cash to patient shareholders.

If the stock market closed down forever, patient shareholders of these “non-dividend-paying” companies will still ultimately start receiving dividends, which ideally should eventually exceed what they paid for the shares. 

However, not all investments pay off. Some investors may have paid too much for a stake in a company. And some high-growth companies that may look promising may never generate enough cash to reward shareholders.

In times like these, I think of another quote from Buffett: “It’s only when the tide goes out that you learn who has been swimming naked.”

In today’s market, investors who only bought a stock hoping to sell it to a “greater fool” at a higher price with no actual cash flow fundamentals behind the stock are unlikely to make back their capital.

Whenever I invest in a stock, I always think about how much cash flow it can potentially generate and whether I can make back what I paid for it simply by collecting the cash flow that I am entitled to over the years. This way, I will never be bothered about dips in share prices as I know I will eventually get more than paid off even if no one offers to buy the shares in the future.

So do you own productive assets you are happy to own forever?

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I do not have a vested interest in any companies mentioned. Holdings are subject to change at any time

Two weeks ago, I was told that my relative had invested in Singapore Post’s (SGX: S08) recently issued perpetual securities.

I thought it would be helpful for my relative if I shared a factual breakdown of the numbers. I also figured that my sharing could be done on The Good Investors to benefit any reader who happens to have invested in or are interested in the same perpetual securities. Before I start, it’s important to note that some key details of the perpetual securities are complex, and I cannot guarantee that my understanding of them is correct. But I think I’m still able to give a good rundown of what’s happening. Here goes!

1) Total sum raised by Singapore Post: S$250 million, excluding any relevant fees

2) Distribution to be paid by Singapore Post for the perpetual securities: There are different distribution rates that Singapore Post will be paying, depending on the time frame:

• There are three time frames. The First Time Frame is from 6 April 2022 to 6 July 2027; the Second Time Frame is from 6 July 2027 to 6 July 2047; and the Third Time Frame refers to 6 July 2047 and beyond.
• For the First Time Frame, Singapore Post will be paying a distribution rate of 4.35% per year.
• For the Second Time Frame, there are a series of Reset Dates, with 6 July 2027 termed the First Reset Date. Each subsequent Reset Date occurs in five-year intervals from 6 July 2027. From 6 July 2027 to the Second Reset Date, Singapore Post will be paying a distribution rate of 2.183% per year, plus 0.25% per year, plus the 5-year SORA-OIS that is seen on 6 July 2027. From the Second Reset Date to the Third Reset Date, Singapore Post will be paying a distribution rate that works out to 2.183% per year, plus 0.25% per year, plus the 5-year SORA-OIS that is seen on the Second Reset Date. For subsequent Reset Dates, the same dynamic for the distribution rate applies. The acronym “SORA-OIS” stands for the Singapore Overnight Rate Average Overnight Indexed Swap. The SORA is an important interest-rate benchmark in Singapore for pricing loans and debt products in the country and the rate can be found here. The SORA-OIS is a derivative of SORA, so the term “5-year SORA-OIS” refers to the SORA-OIS with a 5-year tenor. Unfortunately, I can’t find any publicly-available pricing data for the 5-year SORA-OIS.  
• For the Third Time Frame, there are also Reset Dates that occur at the same five-year intervals. From 6 July 2047 to the next Reset Date, Singapore Post will be paying a distribution rate of 2.183% per year, plus 1.0% per year, plus the 5-year SORA-OIS that is seen on 6 July 2047. From the next Reset Date to the next-next Reset Date, Singapore Post will be paying a distribution rate of 2.183% per year, plus 1.0% per year, plus the 5-year SORA-OIS that is seen on the next Reset Date. For subsequent Reset Dates, the same dynamic for the distribution rate applies.

3) Implication of the distribution to be paid by Singapore Post: As mentioned, the distributions for the Second Time Frame and Third Time Frame involve a fixed distribution rate ranging from 2.433% (2.183% plus 0.25%) to 3.183% (2.183% plus 1.0%). Both are lower than the distribution rate for the First Time Frame. Meanwhile, the distribution rates for the Second Time Frame and Third Time Frame also have a floating-rate component that depends on the 5-year SORA-OIS – and the 5-year SORA-OIS can fluctuate with time. Because of these dynamics, the overall distribution rate for the Second Time Frame and Third Time Frame could be lower than the rate for the First Time Frame.

4) When will the distribution of the perpetual securities be paid by Singapore Post: Singapore Post will pay the distribution twice every year, on 6 January and 6 July in each year.

5) Will Singapore Post return the capital: Singapore Post can choose to redeem the perpetual securities any time within three months of 6 July 2027, or on each distribution-payment-date that comes after 6 July 2027. But Singapore Post has no obligation to redeem the perpetual securities. This means the capital an investor uses to invest in the perpetual securities will be permanently locked up inside Singapore Post if the company does not redeem them. Of course, there’s the option for the investor to sell his or her perpetual securities on the open market – but in this scenario the sale price would be determined by market conditions as well as the business-health of Singapore Post.

6) When will the perpetual securities be available for trading on the Singapore Exchange: The perpetual securities were listed for trading on 7 April 2022.

7) Can Singapore Post afford to pay the distribution attached to the perpetual securities: I can calculate with certainty that the distributions for the perpetual securities for the First Time Frame will cost Singapore Post S$10.875 million annually (4.35% of S$250 million). But it is impossible to answer definitively whether the company can afford to pay the distributions. The best an investor can do is to determine the riskiness of the perpetual securities by looking at Singapore Post’s financial condition. On this front, there are a few things to note, both positive and negative (data’s from Tikr):

• On the positive end, Singapore Post has been generating positive operating cash flow in each financial year going back to at least the last 10, and each year’s operating cash flow is comfortably higher than S$10.875 million as shown in Table 1 below.
• On another positive end (though this is only slightly positive), Singapore Post has a balance sheet with slightly more cash than debt; as of 30 September 2021, the company’s cash and debt stood at S$465.0 million and S$308.4 million, respectively.
• On the negative end, Table 1 makes it clear that Singapore Post has failed to produce any sustained growth in operating cash flow for a long time.    

8) Can Singapore Post choose to not pay the distributions attached to the perpetual securities: Yes, Singapore Post can, at its sole discretion, choose not to pay the distributions – and it can choose not to pay the distributions in perpetuity. But doing so comes at a massive cost to Singapore Post; for example, the company will not be allowed to pay any dividend to owners of its ordinary shares. But since Singapore Post can still choose to not pay the distributions on the perpetual securities, in the worst case scenario, an investor who invests in the perpetual securities could find his or her capital permanently locked up in Singapore Post, and yet receive zero income. 

9) Final word: To repeat, what I’m doing here is merely providing a factual breakdown of Singapore Post’s latest perpetual securities based on publicly available information – I’m not trying to make a case for or against an investment in them. To whoever’s reading this, I hope laying out these numbers will help you make a better-informed decision on Singapore Post’s latest perpetual securities.

---

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I do not have a vested interest in any company mentioned. Holdings are subject to change at any time

Tencent distributed most of its stake in JD.com to its shareholders earlier this year. If you are a shareholder of Tencent, you would notice new shares of JD.com deposited in your account.

What now?

Investors who were given the JD.com shares can now decide if they want to hold on to the shares or simply sell them.

Here’s what you should know before making a decision.

What is JD.com

JD.com is one of the largest e-commerce companies in China. The company started as a traditional brick and mortar retailer in 1998 before transitioning online in the early 2000s. JD.com focused on selling its own electronics inventory and built out a wide logistics network.

Today JD.com is also a marketplace for third-party sellers who want to leverage the company’s massive base of more than 500 million annual active users. 

Unlike Alibaba which is an asset-light business that relies heavily on third-party logistics players, JD.com primarily uses its own logistics capabilities after years of investments building warehouses and expanding its logistics network. This makes JD.com a formidable force in China’s e-commerce scene.

Growing fast

The e-commerce giant recorded a 27% increase in net revenue to RMB 951.6 billion in 2021. Its annual active customer accounts also grew 20.7% to a whopping 569 million. 

From 2018 to 2021, JD.com’s net revenue compounded at 27% per year and annual active customer accounts grew 23% annually. 

There have been broad-based growth across JD.com’s business. All of its segments – including retail, logistics, and new businesses – have recorded strong growth.

Innovation and competition

JD.com is well-known as an e-commerce brand that specialises in electronics. But building from that niche, the company has executed admirably to expand into different product categories.

The tech-focused company has also seen its early investments in logistics paying off as it is now able to offer quick deliveries and has control of its own fulfilment. It also offers its logistics capabilities to its third-party sellers and other customers who want to leverage its sprawling fulfilment network.

JD.com competes with other e-commerce companies in China such as Alibaba and Pinduoduo, but JD.com has been able to hold its own against these other giants.

Innovation also seems to be ingrained in the company’s DNA as JD.com has consistently used technology and data to improve its logistics capabilities and it is also constantly moving into new businesses to leverage on its large user base. It is now building out its JD Health business for telemedicine and has also established a strategic partnership with Shopify to allow Shopify’s merchants to list their products on JD.com. Shopify is a Canada-based global e-commerce software services provider.

Bearing fruit

JD.com’s early investments are starting to bear fruit. It started to generate a chunky stream of free cash flow in the last couple of years.

In the last two years, JD.com generated a combined RMB 61 billion (US$9.6 billion) in free cash flow. This includes JD.com’s increased investments in capital expenditures for business-expansion this year.

Valuation

With China stocks still out of favour, JD.com’s shares are now trading well below their all-time highs. As of 21 March 2022, JD.com’s share price of HK$239 translates to a market cap of HK$748 billion (US$96 billion). At this price, JD.com trades at around 23 times trailing free cash flow.

Conclusion

The distribution of JD.com shares by Tencent to its shareholders have left many investors holding on to shares of a company that they may not be very familiar with. The above summary provides investors with a quick brief of the company and its fundamentals and its valuation.

Although there is still a lot of uncertainty surrounding China at the moment, I think JD.com shares at this valuation still provides investors with a good risk-reward ratio. Nevertheless, each investor is different and investors should do their own due diligence and make a decision based on their own portfolio situation.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. Of all the companies mentioned, I currently have a vested interest in Tencent and JD.com. Holdings are subject to change at any time.

Zoom Video Communications (NASDAQ: ZM) reported its financial year 2022 (FY2022) fourth-quarter results earlier this week.

During Zoom’s earnings call, management expressed optimism around the company’s new product, Zoom Contact Centre, and the strong growth trajectory of Zoom Phones. The earnings call transcript is worth a read for more insight into the business but in this article, I want to specifically dive into some of Zoom’s key numbers and earnings projections and share my views on the company’s current stock price.

Sequential growth decelerates but is expected to pick up in FY2023

Zoom was one of the major beneficiaries of COVID-19 lockdowns as people resorted to video conferencing tools to communicate. 

But since peaking in 2021, Zoom’s growth rate has been decelerating due to a combination of churn and slower customer wins. In fact, Zoom reported a sequential decline in the number of customers who employed more than 10 employees in the fourth quarter of FY2022. This was a result of churn as some of these customers did not renew subscriptions as social-distancing measures were relaxed.

The table below shows Zoom’s revenue figures on a quarterly basis:

Zoom’s sequential revenue growth has been on a steady decline since the 102% spike seen in the second quarter of FY2021. Zoom is also projecting flat sequential growth for the first quarter of FY2023. Although the trend above looks worrying, I believe that Zoom’s sequential growth will start to improve in the second half of FY2023 as customer churn reduces.

This is because the world is now crossing the 2-year anniversary of the start of COVID-induced lockdowns in many parts of the world. This is a period when some of Zoom’s customers will decide whether or not to renew their contracts.

Zoom’s customer base is usually very sticky. But in this unique situation, churn is especially high as some customers who started subscribing to Zoom during the lockdowns do not intend to stick around after COVID. 

Once Zoom moves past this relatively higher churn period, the company’s churn rate will likely decrease. Beyond this, new customer wins can also start to improve Zoom’s top-line, rather than just replace leaving customers.

Growth in remaining performance obligation

Another good sign is that there was a sequential acceleration in Zoom’s RPO (remaining performance obligations) growth. RPO essentially refers to revenue that Zoom will recognise in the future.

The table below is a compilation of the company’s RPO over the past 12 quarters.

RPO growth accelerated in the fourth quarter of FY2022 compared to the previous sequential quarter. This is a sign of successful customer wins which sets Zoom up nicely for the future.

Management guidance for FY2023

Zoom’s management also provided guidance for FY2023 that indicates around 10.8% growth in revenue for the year. The table below shows Zoom’s full-year revenue growth rate and guidance for FY2023.

Taking into account the projections for revenue of US$1.07 billion in the first quarter of FY2023, revenue for the remaining three quarters of FY2023 will need to grow sequentially in order to hit management’s revenue projections for the year. Based on my calculations, Zoom’s revenue will have to increase by slightly more than 4% sequentially each quarter, starting from the second quarter of FY2023.

I believe Zoom can achieve growth by winning customers for its core product of video conferencing or selling some of its newer less-penetrated products such as Zoom Phones and Zoom Contact Centre. It is also worth pointing out that Zoom has exceeded its own projections every quarter since its IPO.

My thoughts on valuation

Zoom’s stock price has cratered from a peak of more than US$560 seen in October 2020 and the company currently has a market capitalisation of around US$36 billion.

At the current stock price of US$122, Zoom has an enterprise value-to-free cash flow (EV-to-FCF) ratio of around 21. This is a discount to other mature, highly-cash-generative software-as-a-service (SaaS) companies. The chart below shows Zoom’s EV-to-FCF ratio compared to these other SaaS companies such as Adobe, Salesforce, and Servicenow.

Although the projected revenue growth of 10% is nowhere near as fast as other software companies, Zoom is trading at what I believe to be an unfairly low valuation. Revenue growth can also possibly accelerate in the future given that Zoom Contact Centre is a new product (launched last month) that management is excited about and Zoom Phone is in a high-growth phase.

Zoom has become a value stock as much as a growth stock at the current stock price. Given this, I think there’s room for the stock to climb in the future.

---

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. Of all the companies mentioned, I currently have a vested interest in Zoom, Adobe, and Salesforce. Holdings are subject to change at any time.

Buying and holding great companies can make you rich. If you invested in Amazon.com (NASDAQ: AMZN) 20 years ago in January 2001 and held it all the way, you’d have generated a return greater than 20,000%. Put another way, an investment of $5,000 will be worth more than a million dollars.

But it’s easier said than done. Not all companies are like Amazon. A study done by JP Morgan found that two-thirds of all stocks underperformed the Russell 3000 index from 1980 to 2014. Moreover, 40% of all stocks had a negative absolute return over that 30-year time frame.

And only a handful of stocks can be classified as “extreme winners” earning investors more than 500% over that time frame. So choosing the right companies to invest and hold is critical. Buying and holding lousy companies will just destroy your portfolio over time.

So what sets the best companies apart?

And even if we had come across such a company back then, would we be able to identify a long-term compounder such as Amazon? I decided to put this to the test by revisiting Amazon’s 1999 IPO prospectus and its 2000 and 2001 annual reports to see if there were any early indications that Amazon would turn out to be a great investment. 

Early signs of innovative spirit

Back then, it was already clear that Jeff Bezos, Amazon’s founder and CEO at the time, was an innovative leader. In 1999, Amazon was listed on the NASDAQ and in its IPO prospectus, the company described itself as a “leading online retailer of books.” Back in 1999, Amazon was still solely a seller of books. By 2002, Amazon had transformed into the “everything” store. In its 2001 annual report, the company’s business description had completely changed from just selling books to selling a whole host of items. The report stated:

“We seek to be the world’s most customer-centric company, where customers can find and discover anything they may want to buy online. We and our sellers list millions of unique items in categories such as books, music, DVDs, videos, electronics, computers, camera and photo items, software, computer and video games, cell phones and service, tools and hardware, outdoor living items, kitchen and houseware products, toys, baby and baby registry, travel services and magazine subscriptions.”

Amazingly, this transition transpired in just three years. In addition, by 2002, Amazon had gone from just a first-party retailer who only sold its own inventory, to operating a vibrant online marketplace where third-party sellers could leverage Amazon’s already loyal customer base.

This willingness to adapt, grow, and expand quickly became an important theme for Amazon over the years as the company not only expanded its e-commerce business rapidly but also grew other lines of businesses over time, such as advertising and Amazon Web Services (AWS). 

Although investors in 2002 would have been hard-pressed to predict the true trajectory of Amazon’s transition from then till today, the clear presence of an innovative spirit within the company could have been an early indicator of its possible future success and adaptations.

It was already demonstrating an excellent execution track record

Besides opening new lines of business, Jeff Bezos and his team were already demonstrating an ability to grow Amazon’s business steadily.

The table below shows selected data extracted from Amazon’s 2001 annual report.

In the five years from 1997 to 2001, Amazon had grown its net sales by a compounded annual rate of 114%. Although growth did slow in 2001, this was due to a shift of product mix from 1st party sales to 3rd party sales and a decline in general economic conditions that year.

We can also see that Amazon’s gross profit margin picked up nicely from 1997 to 2001 due to this shift from lower margin first-party sales to its services business where it served its third-party sellers on its marketplace.

It was in the early innings of an E-commerce boom

Although not many of us can say we could foresee the extent of the potential of e-commerce at that time, it was pretty clear that it was still a nascent market that was growing rapidly.

In its prospectus, Amazon argued why it believed online booksellers would keep on growing. It said:

“Amazon.com was founded to capitalize on the opportunity for online book retailing. The Company believes that the retail book industry is particularly suited to online retailing for many compelling reasons. An online bookseller has virtually unlimited online shelf space and can offer customers a vast selection through an efficient search and retrieval interface. This is particularly valuable in the book market because the extraordinary number of different items precludes even the largest physical bookstore from economically stocking more than a small minority of available titles. In addition, by serving a large and global market through centralized distribution and operations, online booksellers can realize significant structural cost advantages relative to traditional booksellers.” 

There’s more:

“Beyond the benefits of selection, purchasing books from Amazon.com is more convenient than shopping in a physical bookstore because online shopping can be done 24 hours a day and does not require a trip to a store. Furthermore, once the Company achieves sufficient sales volume to realize economies of scale, the Company believes that its high inventory turnover, lack of investment in expensive retail real estate and reduced personnel requirements will give it meaningful structural economic advantages relative to traditional booksellers.”

An investor reading this back then would realise the vast potential of online retail due to the numerous advantages it has over traditional retailing. Amazon looked set to take advantage of a major transformation in consumer behaviour.

Amazon had cheap access to capital

Another great trait for a company to have is easy access to capital. This will provide a company with the financial muscle to grow existing businesses and invest in new lines of business.

In 2002, Amazon had just raised what was then a massive US$1.25 billion in new funding by selling 10-year convertible notes with interest of 4.75% and a convertible feature at a 27% premium to its stock price at that time. 

Investor-appetite for Amazon’s convertible notes is comforting for shareholders because it indicates that the company will be able to keep funding its growth.

Although Amazon’s balance sheet ended up with more long-term debt than cash in 2002 due to the sale of the convertible notes, the notes had a 10-year expiry and could be converted to shares – the convertible feature can save the company from having to repay the principal. This meant Amazon’s financial health was still very strong, despite losing money since its founding.

This relatively cheap source of capital for Amazon at that time also made its balance sheet a lot more robust, giving it the platform to invest aggressively for growth.

Were there any negatives?

After going through the prospectus and annual reports during its early years, I found some negatives to its business.

For one, the company was generating negative cash flow. Gross profit was growing, but the company was still spending heavily on expanding, new hires and marketing. 

I could also predict that there was going to be heavy dilution due to stock-based compensation to employees and the conversion of the aforementioned long-term convertible notes. The company will need to grow its market cap faster than the dilution for investors to reap a profit.

Amazon was also an unproven business. It had a relatively short existence back then and was still not profitable. Sceptics wondered whether the business could ever turn a profit.

Would you have invested?

It is invariably easier to look back on a big winner and say that the signs were obvious. But is that really the case?

In Amazon’s instance, there were many things to like about the company. Some of the traits of its business and its management were hallmarks of a company that could go on to be a big winner. But at the same time, there were some concerns that were likely difficult to look beyond at that time. 

Looking back now, do you think that you would have invested in Amazon if you had studied the company in its early years?

---

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. Of all the companies mentioned, I currently have a vested interest in Amazon. Holdings are subject to change at any time.