Month: August 2020

Tencent is the largest video game company in the world and operates some of the largest online social platforms in China. Prosus owns 31 percent of Tencent. Valued at $660 billion (R11.4 trillion), Tencent is the second-largest Chinese company after Alibaba. The company derives its revenue from online and mobile games, internet services, social network and music platforms, online commerce, and payment services.  Its social media app WeChat has over 1.2 billion users; close to 86 percent of China’s population. Tencent has also become one of the largest venture capital and investment firms globally. Management has a remarkable ability to identify and partner with entrepreneurs outside of its own circle of competence. To date, Tencent has invested in more than 800 companies, 160 of which are valued at more than $1 billion. Of the 800, 70 are listed on stock exchanges. Tencent owns 5 percent of Tesla and 9 percent of Spotify, for example.

Tencent cruised through the pandemic as more people stayed home and played games during lockdowns. It reported a healthy set of quarterly results, underpinned by smartphone gaming revenues growing 62 percent over the past year. All of its core business units were structurally resistant to the health crisis and generated double-digit revenue growth. Total revenue rose 26 percent on an annual basis. Early in August Tencent’s share price dipped after the Trump administration issued an executive order banning WeChat in the United States from 20 September 2020. Trump alleges that WeChat poses a threat to United States national security because the Chinese Communist Party may gain access to the vast amounts of personal information gathered by the app. The order prohibits any transaction that is related to WeChat by any person subject to United States jurisdiction. The order has caused interpretative uncertainty, but is primarily allegorical as American users of WeChat represent less than two percent of the total number of users. So, from a revenue point of view the impact is immaterial for Tencent. Although the administration could potentially increase its efforts to restrict Tencent and WeChat, this would be detrimental to American companies. For example, iPhone sales in China account for 16 percent of Apple’s revenue. If Apple is forced to drop WeChat from its Chinese App Store, this would effectively halt iPhone sales in China. Senior administration officials have, however, apparently been reaching out to some US companies, seeking to reassure them that they can still do business with Tencent’s WeChat app.

Tencent benefits from a dominant position in the Chinese internet and social media industries. It continues to prudently manage the growth and monetisation of its enormous user base. Tencent generates stable cash flows and is investing heavily in its gaming business, as well as payments and cloud computing. It maintains the relevance of its ecosystem through innovative upgrades and features. Tencent is a high-quality company with various growth drivers and multiple competitive advantages. Tencent is an attractive long-term investment and its share price has increased nearly 60 percent over the past year. It is not a bargain at nearly 40 times forward earnings, but its sustainable earnings growth arguably justifies the premium.

Frants Preis, CFA is a portfolio manager at VEGA Asset Management based in Pretoria. Tencent shares are held on behalf of clients.

Paris-based L’Oréal is the world’s most valuable cosmetics company. It manufactures 7 billion beauty products annually. At a market value of R3.2 trillion it is larger than Estée Lauder, Colgate-Palmolive and Beiersdorf combined. The company has over 497 registered patents and 36 global brands with thousands of products in fields focusing on hair colour and care, make-up, skincare, sun protection, and perfume. Brands include Garnier, Maybelline, Kérastase, The Body Shop and beauty products of Yves Saint Laurent, Lancôme and Giorgio Armani. Nestlé owns 23 percent of L’Oréal.

Since its inception 111 years ago, research and development have played a crucial rule in L’Oréal’s success. It has had many industry firsts, including soap-free shampoo and foam bath. The company has 21 research and development centres and 42 manufacturing plants across the globe. L’Oréal has been against testing products on animals and has spent at least R18 billion on research to find an alternative. They developed Episkin, which is reconstructed skin that acts as an alternative for testing on animals. L’Oréal does not test products or ingredients on animals. However, it sells cosmetics in China that are required by Chinese law to be tested on animals.

L’Oréal reported resilient bi-annual results last week. The consumption of beauty products over the period was strongly impacted by the closure of millions of points of sale as a result of the COVID-19 pandemic. This caused a crisis of supply, rather than demand, since consumers were temporarily unable to purchase products. As part of its solidarity programme, L’Oréal used its facilities to make and donate over 15 million units of hand sanitiser gel and moisturising cream for medical officials in need. Although L’Oréal’s revenue in the first half declined 12 percent, its sales in China increased by 17.5 percent and online sales grew 65 percent – a further sign that the pandemic is accelerating a digital shift among retailers worldwide. Online sales now comprise a quarter of its total revenue. CEO Jean-Paul Agon announced that L’Oréal will embark on an aggressive plan of new product launches and advertising campaigns to remain competitive in a market that has been reshaped by the pandemic.

The global cosmetics market has grown steadily at approximately 4 percent per annum. It is a market driven by the development of social media, increasing urbanisation and rising growth in online beauty spending due to the expected growth of the high-income class over the next decade. L’Oréal’s strong and diversified brand portfolio enables it to lead the industry in terms of margins and organic growth. It is also the market leader in research and development capabilities in the cosmetics industry. Increasing demand for cosmetic products in China offers significant opportunity, but also intensifies competition. The country’s animal testing policies remain a contentious issue. L’Oréal shares offer investors a defensive profile, but are currently trading at record highs and at a premium to peers and itself.

Frants Preis, CFA is a portfolio manager at VEGA Asset Management based in Pretoria.