In recent years, the Chinese internet sector has experienced significant shifts, especially as the once-thriving growth profiles of many online companies have faced mounting pressuresThe days of rapid expansion and soaring stock values, often characterized by tenfold increases, seem to have given way to a new era where companies are grappling with the impacts of stagnating user growth and an evolving regulatory environmentThis predicament doesn’t just hinder performance; it also casts a long shadow over the valuations of these companiesHowever, a glance at the latest earnings reports reveals a glimmer of hope and suggests that the internet market may be poised for a rebound.

Leading firms such as Tencent, Meituan, and Alibaba, once under intense scrutiny due to their performance, have reported substantial recoveries in their earnings, signaling a potential revivalAs these companies embark on aggressive stock repurchase plans, many wonder if this is indeed the time to invest

With their stocks trading at lower valuations, an improving earnings picture, and substantial buyback activity, could the internet sector be on the verge of a new investment opportunity?

Let's delve into the financial performance of these major playersTencent, for instance, demonstrated a robust gross margin of 53% in the second quarter, up six percentage points year-over-yearThe profits generated from value-added services, online advertising, and fintech exhibited year-over-year increases of 3%, 7%, and 9%, respectivelyInterestingly, despite the challenges posed by game licensing and product cycles, Tencent's advertising sector has blossomed, with revenues rising significantlyThis pivot illustrates how different segments within these companies can complement each other and mitigate potential downturns in specific areas.

Meituan, too, has showcased impressive growth in its core local services segment

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In the second quarter, its profit was recorded at 15.2 billion yuan, far exceeding market expectations of 12.3 billion yuanThe operating profit margin for local commerce reached a record high of 25.1%, reflecting an uptick of approximately 3.3 percentage points compared to the previous yearWhat's particularly noteworthy is how Meituan managed to improve its profitability not merely by cutting costs but through enhancing operational efficiency and improving competitive dynamics within its market.

Another significant player, JD.com, has also reported healthy profit growthIts non-GAAP net income in the second quarter hit 14.5 billion yuan, with a net profit margin of 5.0%, a rise of 2.0 percentage points from the previous yearIt’s clear that these companies have not just weathered the storm; they are adapting and evolving their business models to not only survive but thrive.

Why are these internet firms experiencing growth in profits despite a challenging marketplace? Two main reasons stand out

Firstly, the competitive landscape in certain segments has stabilized, allowing these companies to shift their focus from merely competing for market share to prioritizing profitability, as illustrated by Meituan's strategic pivotSecondly, the bargaining power that arises from being a dominant player in their respective niches has enabled these firms to make more strategic adjustments to boost earningsTencent's expansion in the advertising sector has successfully offset stagnation in the gaming segment, showcasing this adaptability.

The proactive stance these companies are taking is further evidenced by their aggressive share buybacksTencent, for instance, has already initiated a substantial repurchase program, with a total buyback amounting to HKD 49.4 billion in 2023 aloneDuring the first half of the year, Tencent, Meituan, and Alibaba reported repurchase amounts of 47.6 billion, 13.9 billion, and 76.7 billion yuan, respectively

Such actions signal a deep-seated belief within these companies’ management teams regarding their future profitability and the potential mispricing of their stocks in the current market.

When you compare the valuations of internet companies on the Hong Kong Stock Exchange with their counterparts in the US, a marked difference appearsMost of the major tech firms on the Nasdaq are trading at a price-to-earnings (P/E) ratio between 25-30x, while their Hong Kong counterparts hover around 15-20x for their adjusted net profits in 2024. This relative undervaluation could indicate a significant investment opportunity for those looking at the long-term potential of these internet stocks.

Additionally, it’s crucial to acknowledge that, even in a historical context, current valuations for internet assets in Hong Kong are at notably low levelsFor instance, as of September 3, 2024, the Hang Seng Tech Index displayed a P/E ratio of 20.79x, sitting at the 18.78th percentile since the inception of the index

This comparison suggests that an average investor might be looking at one of the most favorable acquisition points in recent history.

The recent earnings releases have attracted the attention of various market participants, underscoring a renewed interest in internet firms with improving financialsFor example, both Meituan and Tencent’s stock prices surged by 8.1% and 5.5% respectively in August, considerably outperforming the Hang Seng Tech Index as their financial resilience gains acknowledgmentThis trend may be an early indication of shifting investor sentiment towards a recovery in the sector.

From a broader perspective, the fundamentals of the internet sector are becoming more favorable as we witness a transformation driven by technologyAs years of investment in R&D begin to bear fruit, these companies are leaning on cutting-edge technologies like big data, cloud computing, and artificial intelligence, which not only enhance operational efficiencies but also foster new business avenues

Moreover, business models evolve from merely monetizing traffic to a diversified approach that focuses on various lucrative streams, such as e-commerce, online services, and digital content, all of which exhibit robust growth potential.

Examining the market landscape further enhances the optimistic outlook for internet assetsIndustry adjustments have weeded out irrational exuberance, leading to valuations that now fall within more reasonable territoriesAs macroeconomic recovery leads to renewed consumer markets, and as internet services become ever more integrated into daily life, the demand for their offerings is forecasted to riseIndicators like user engagement and time spent on platforms are showing positive trends, hinting at a potential new value growth phase for internet companiesTherefore, it appears that now may indeed be an opportune moment for savvy investors to enter this bustling sector.