China’s Internet sector wrapped up the third quarter earnings season with its slowest growth on record.
Aggregate revenue for the five largest companies climbed 31.5% for the three months ended September, the third consecutive quarter of slowdown.
That doesn’t look too shabby. Any company or industry that manages to sustain such numbers for any period of time shouldn’t be easily dismissed.
But there are increasing signs that even this slower rate is flimsy. That’s because profits are actually dropping.
I analysed the top companies by market capitalisation: Baidu, Alibaba Group, Tencent Holdings, JD.Com and NetEase. Neither Meituan Dianping or Pinduoduo was included because of their shorter earnings track records.
For the September period, aggregate operating income fell 0.3%, after plunging 24% in the June quarter. Tencent was the only one that posted higher operating income, and even that’s misleading because 31% of its profit came from gains beyond its core business.
That tells us it’s time to look past those stellar top-line numbers and drill down. Revenue growth isn’t worth much if profit margins keep shrinking. That’s exactly what happened in the most recent two quarters, with September’s uptick being overstated due to Tencent’s one-time gains.
‘Building a moat’
There was a time when companies could get away with sacrificing margins in return for revenue growth. The thinking was that this could buy market share and loyalty. In start-up parlance it’s known as “building a moat”.
This strategy no longer works. When profits are declining simply to prop up revenue growth, things have gone too far.
China’s Internet giants are grown-ups now. It’s time they started acting like it. — Reported by Tim Culpan, (c) 2018 Bloomberg LP