As Chinese tech stocks bounce back, a new normal will test upside down

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(Bloomberg) — Chinese technology stocks are suddenly back in favor of Wall Street, but that doesn’t mean investors and analysts expect the sector to regain its former glory anytime soon, if ever.

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From Goldman Sachs Group Inc. to Morgan Stanley, a growing number of strategists have made bullish statements following President Xi Jinping’s departure from Covid Zero, promising to end the crackdown on the sector. The shifts have led to a 60% increase in the Hang Seng Tech Index since a low in October, a world-class performance even though the meter’s market value is still half its February 2021 peak.

While few doubt that the worst is over, a greater question looms over the fair valuation of the sector under a regulatory regime where free growth is no longer tolerated, and as the sector matures.

“Chinese technology stocks used to be the easiest bet, and for most of the past decade you could win and see outperformance without doing much,” said Chen Da, general manager of Fortune Hill Asset Management Ltd. “It’s possible we’ll never see those times again.”

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The outlook for the sector has changed dramatically since the beginning of last year, when some of the largest banks questioned whether the sector was ‘investable’.

After two consecutive years of losses, markets are brimming with hope over the sector’s returns as there are growing signs of a more lenient stance from the authorities. Guo Shuqing, party secretary of the People’s Bank of China, said this month that a regulatory review is coming to an end.

That, coupled with the reopening and easing of tensions with the US, has led to a wave of price target increases across the industry, including for Alibaba Group Holding Ltd. and Tencent Holdings Ltd., though targets are well short of their highs.

New Normal

“There’s a growth story to tell, but it’s not a very fast growth rate, growth that’s higher than utilities and more stable than cyclicals,” said Fortune Hill’s Chen. “I think it makes sense to think of the cohort more as consumer durables.”

Alibaba’s forward price-to-earnings ratio only recently surpassed that of electricity supplier CLP Holdings Ltd. annual average for natural gas operator ENN Energy Holdings Ltd.

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Meanwhile, the valuation of the Hang Seng Tech Index peaked at about 46 times future earnings in 2021 and bottomed out at 17 in October 2022, and currently stands at about 27 – comparable to consumer companies such as Li Ning Co. and Budweiser Brewing Co APAC.

“There will be a greater discrepancy within the industry after the best years of their growth are largely over,” said Zhuang Jiapeng, a fund manager at Shenzhen JM Capital Co. “The valuations we can expect under the new economic cycle will be very different depending on the company….”

According to Goldman Sachs analysts including Ronald Keung, the internet sector is still up 20%, driven by valuation expansion after two years of contraction and rebounding in revenue growth this year.

Ongoing Risks

Certainly, technology is a rapidly evolving space that could see a second growth curve with new developments, and the sheer size of the Chinese market makes it an attractive investment destination for some.

“When you look at how that sector has been down a lot in recent years, valuations aren’t extremely tense either,” Christina Woon, investment director for Asian equities at abrdn plc, said in an interview with Bloomberg TV. “So all in all, that’s a pretty compelling case to keep an eye on.”

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But lingering regulatory risks can make assessing the sector’s fair value a complicated task. A sweeping crackdown on the sector has come to an end, but that doesn’t mean authorities are letting go of intense surveillance.

On Friday, a report said government agencies will take so-called “gold shares” in units of Alibaba and Tencent, possibly pointing to increased state influence. Last month, the government published a new set of restrictions on private tutoring services for students, increasing pressure on so-called edtech companies.

“It’s only been a few months since we stopped asking them questions about investability, about weak regulation,” said David Perrett, co-head of Asian equities at M&G Investment Management. “The point is that regulatory concerns are in the price. And that is very different from where they were two years ago.”

–With help from Aya Wagatsuma.

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