Major Chinese internet companies are prioritising investments in 2021, which will slow their high-profit growth for a year or two, Fitch Ratings says. The financial performances of the major companies is expected to diverge.
For China’s internet majors ‒ Alibaba Group Holding Limited (A+/Stable), Tencent Holdings Limited (A+/Stable), and Baidu, Inc. (A/Stable) – growth in aggregate operating EBIT is expected to slow to a mid-single-digit in 2021, from 24% in 2020. At the same time, aggregate operating EBIT margin will narrow by four percentage points to 20%, as the companies invest to strengthen technology and content, support ecosystem partners, and improve access to new markets.
The investment cycle could extend to 2022 or beyond, though it’s believed it will likely peak in 2021. Nevertheless, the companies’ financial profiles should remain solid and the investments should help enhance business profiles and revenue opportunities.
Alibaba’s rating headroom should remain high, as the company has a low gross leverage of less than 1x, high annual free cash flow (FCF) generation of over CNY150 billion, and a large net cash position. Alibaba’s cash and short-term investments totalled CNY474 billion at end-March 2021, compared with a reported debt of CNY149 billion. Alibaba does not need rapid profit growth to maintain its strong financial profile.
Alibaba’s operating EBIT is expected to increase by the low single-digits in the financial year ending March 2022 (FY22). The company plans to invest all incremental profit in FY22 in technology innovation, support programmes for merchants to lower operating costs, user acquisition, merchandising and supply chain capabilities, infrastructure development, and new businesses. The company aims to expand its annual active consumers in China to over 1 billion in FY22 (FY21: 891 million).
Tencent’s and Baidu’s rating headroom will remain moderate. Tencent’s operating EBIT is expected to rise faster in 2021 than its peers’, but the growth rate will likely slow to the low- to mid-teens in 2021 (2020: 32%). Unlike Alibaba, which is investing all its incremental profit, Tencent is investing a portion of incremental profit, particularly in business services, games, and short-form video content. Its operating EBIT margin eased in 1Q21, but was still high at 30% (1Q20: 34%). Reported net cash dropped to CNY5.6 billion at end-March 2021, from CNY11.1 billion at end-December 2020, due to higher M&A spending.
Baidu is likely to face more earnings pressure in 2021 than the other two companies as it shifts focus to front-loaded operating expenditure. Selling, general and administrative expenses for Baidu’s core businesses rose 58% yoy in 1Q21 to the equivalent of 20% of Baidu’s core revenue (2020: 17%), reflecting an increase in channel spending and promotional expenses, higher R&D expenditure, and expansion of the sales force. A recovery is expected in Baidu’s core marketing revenue and the consolidation of YY Live to limit the pressure on earnings and FCF.
Baidu aims to expand in artificial intelligent (AI) cloud solutions for enterprises and smart transportation projects for the government. The company is hiring sales staff for the new AI businesses. Baidu will also start investing in its smart electric-vehicle business.
Baidu’s FFO leverage is forecast to stay above 2.0x in 2021 and 2022. However, the company’s core marketing FCF generation should remain robust and its large net cash position should help fund the company’s AI initiatives. Baidu and iQIYI, Inc. had combined cash plus short-term investments of CNY162 billion at end-March 2021, compared with total debt of about CNY80 billion.
