HSBC lifts Tencent Music shares target on gross margin boost

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Written By Pinang Driod

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On Wednesday, HSBC updated its outlook on Tencent Music Entertainment Group (NYSE:), raising the price target for the shares to $10.40 from the previous $9.50, while keeping a Hold rating on the stock.

The adjustment reflects a more favorable view on the company’s gross margin expansion, which outperformed expectations in the fourth quarter of 2023 due to a strong online music gross profit margin (GPM). The revised gross profit margin forecasts for 2024 and 2025 are now set at 39.7% and 40.9%, respectively, up from the earlier projections of 36.9% and 37.5%.

The financial institution cited several factors contributing to the gross margin improvement, including the online music segment’s incremental operating leverage, an increased share of advertising revenue, and the growth of self-developed content.

These elements are anticipated to continue bolstering the gross margin into 2024 and beyond. Nevertheless, potential increases in marketing and general and administrative spending aimed at enhancing the paying user ratio through product upgrades and expansion into new channels could partially counterbalance these positive developments.

Despite the positive outlook on gross profit, HSBC has only marginally lifted its non-GAAP net profit forecasts for 2024 and 2025 by 3% and 4%, respectively. The firm attributes this conservative revision to the anticipation of a higher tax rate resulting from additional withholding taxes. The analyst also marginally increased the top-line revenue forecast by 3%.

The report from HSBC suggests that while the stronger-than-expected gross profit outlook is a positive sign, the current valuation of Tencent Music is considered fair, with the stock trading at 17 times the estimated 2024 earnings per share (P/E) against a non-GAAP diluted earnings per share compound annual growth rate (CAGR) of 16% for 2024-2025.

The firm also noted Tencent Music’s ongoing efforts to return value to shareholders, including share buybacks and the evaluation of other options, such as the potential issuance of dividends. A 2% return to shareholders has been factored into the 2024 projections.

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