ab4 January 2024Global Research and Evidence LabChina Internet Sector2024 outlook: From macro to micro callsLooking for visible micro drivers after a choppy 2023Into 2024, we continue to seek bottom-up drivers as silver linings amid uncertain macro conditions (see our full report [link]). After a brief rally in 1Q23, KWEB corrected by ~15% last year as the economy recovery momentum was weaker than expected post-Covid reopening. Looking back, few lessons from 2023: 1) Bottom-up drivers lead to significant alpha (PDD and NetEase) 2) Margin outlook is key amid a weak near-term macro (BABA and Meituan's post-3Q result sharp price correction on additional investments as margin drag), 3) Macro outlook is still weak, and 4) Cheap stock can get cheaper unless with aggressive share buyback. With that, we suggest investors to focus on bottom up drivers to identify the potential winner for 2024.6 themes into 2024Into 2024, we continue to see that internet companies not only face slower macro and peaked user growth, but also structural changes among users. Users are becoming more selective regarding service, personalized about demand and value-focused in terms of products. We identify the following 6 key sector themes 2024: 1) Competition: to remain intense within and across segments, i.e. e-commerce, local services and online games; 2) Optimization of traffic monetization: Ranked by room for a potential surprise, we suggest investors to focus on Tencent's Weixin ecosystem, JD's restructuring, Alibaba's WanXiangTai Unbounded, Bilibili working with e-com platforms and Meituan's PinHaoFan and Insta-shopping initiatives; 3) Overseas markets offer blue skies in this competitive markets (i.e. PDD's Temu and overseas games), 4) Profit growth takes driver's seat (profit redistribution along industry value chain for e-com and online games, cutting down loss making business and revenue mix enhancement); 5) Shareholder return (BABA could offer upside surprise given its strong FCF and potential disposal of non-core assets); and 6) AI investments would be helpful on cost optimization and monetization, but take time for meaningful contribution, in our view. Sector view: Likely a back-end loaded recovery; focus on bottom-up drivers.We still view the sector’s risk-reward attractive, on undemanding valuation (13x 2024 PE), with light investor positioning, a supportive regulatory backdrop, eventually improving macro and room for a margin uplift backed by companies’ operating enhancement. However, with the macro recovery taking time to build momentum, investor sentiment is likely to remain fragile near term, in our view. Stock calls: A diverging trend in 1H24 and 2H24Into 1H24, amid the uncertain timing of the macro recovery, we think companies with product-specific drivers, earnings visibility (esp. on margins) and proactive buybacks could outperform. We like Tencent (earnin...
