Tencent’s Q1 core profit rose 17%, with AI emerging as a new growth driver.

Overview

Bernstein commented on Tencent Holdings’ Q1 2026 results, noting that while headline revenue growth (9.1%) edged below the market consensus, the company’s underlying fundamentals remain robust and are gaining momentum. The report underscores that, excluding the firm’s substantial strategic investments in artificial intelligence (AI), its core businesses delivered a strong year-over-year operating profit increase of 17.4%. The firm remains optimistic about Tencent’s growth prospects in advertising and cloud services, as well as the long-term competitive advantages driven by AI technologies, maintaining an “Outperform” rating with a target price of HK$780.

Core views

Discrepancies Between Reported Results and Underlying Fundamentals: Tencent’s Q1 revenue totaled RMB 196.5 billion, up 9.1% year over year—slightly below Bernstein’s estimate of RMB 197.6 billion and the market consensus of RMB 199.4 billion. Management noted that, had it not been for the later timing of the Lunar New Year—which deferred some game‑related revenue recognition to after the quarter’s end—the growth rate would have reached 11%. Nevertheless, gross profit rose 10.7% year over year to RMB 111.3 billion, with gross margin expanding further to 56.6%. The True Pace of Core Profit Growth: The report underscores the importance of assessing core‑business profitability after stripping out the impact of AI‑related investments. Non‑GAAP operating profit for Q1 was RMB 75.6 billion, up 9.1% year over year; however, excluding disclosed AI‑related expenses, core‑business operating profit surged to RMB 84.4 billion, a robust 17.4% increase from RMB 71.9 billion in the same period last year. This indicates that, while maintaining high margins, the company is actively leveraging AI investments to fuel future growth momentum. Segment Highlights: 1. Gaming: Revenue reached RMB 64.2 billion, up 7.9% year over year. Domestic and international gaming revenues grew 5.9% and 13%, respectively (14% on a constant‑currency basis). Notably, the balance of deferred revenue at quarter‑end increased 15% year over year, exceeding model expectations, suggesting potential 15–16% growth in future game billings. Despite a relatively subdued pipeline of new titles slated for 2026, key franchises such as “Delta Force” and “Valorant” continue to deliver strong performance. 2. Online Advertising: Revenue totaled RMB 38.2 billion, up 19.8% year over year—outpacing market expectations. This growth was supported by room for improvement in video‑ad load rates and higher ad‑unit prices driven by enhanced targeting technologies. However, the segment’s gross margin fell slightly short of expectations. 3. FinTech and Enterprise Services (FBS): Revenue stood at RMB 59.9 billion, up 9.1% year over year. Within this segment, enterprise services—including Tencent Cloud and e‑commerce—posted a robust 20% growth, reflecting a clear recovery in B2B demand. Overall FBS gross margin also exceeded expectations. AI Strategy and Capital Expenditures: During the earnings call, management highlighted that, following the release of the Hunyuan 3 preview version, the company has rearchitected its data pipelines and training, reinforcement learning, and evaluation infrastructure. A substantially improved model iteration is expected later this year. Additionally, with the delivery of domestically produced ASIC chips in the second half of 2026, Tencent Cloud’s capital spending is anticipated to ramp up, bolstering its ability to serve external customers.

Analysis framework

The firm adopts a “core‑profit‑restoration” analytical framework. Given that Tencent is currently in a phase of substantial AI investment, relying solely on reported earnings could understate the health of its core businesses. Accordingly, analysts strip AI‑related R&D and capital expenditures from operating profit and calculate a separate “core‑business profit” metric, enabling them to assess the organic growth momentum of the company’s traditional strengths—gaming, advertising, and social networking. In addition, the report incorporates forward‑looking indicators: for instance, it uses the growth in “deferred revenue balance” to forecast future gaming revenue streams, rather than focusing exclusively on current‑period recognized revenue. As for valuation, the firm employs a forward P/E approach, assigning a target price based on an expected earnings per share of 20 times FY+1—i.e., over the next four quarters.

Methodology notes

• Company Fundamentals and Financial FrameworkProfit Quality Analysis

  Excluding one-off or strategically significant large expenditures (such as AI-related investments) to assess the true earnings trajectory of the core business.

  The research report adjusts for AI-related expenditures to calculate core operating profit, enabling investors to distinguish between “strategic losses/investments” and “operational deterioration” and thereby more accurately assess the company’s ability to generate cash from its core business.

• Industry/ Sector Analysis FrameworkSupply-and-Demand Framework

  Forecasting future game revenue through deferred revenue.

  In the gaming industry, deferred revenue represents funds that have been prepaid by users but have not yet been recognized as revenue, serving as a leading indicator of future quarterly revenue growth. Based on this, the research report infers the game business’s potential for sustained growth going forward.

• Valuation MethodologyPE/PEG valuation

  Valuation using the forward price-to-earnings ratio (Forward PE)

  The research report employs a forward‑year (FY+1) price‑earnings ratio of 20x to derive the target price, a valuation benchmark commonly used for growth‑tech companies that reflects the market’s pricing of future earnings growth.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• Tencent Holdings (0700.HK)

  Beneficiary: Acceleration of core business and deepening AI strategy

  Strengths

  Advertising revenue growth has exceeded expectations; Video Accounts boast significant monetization potential; cloud services are seeing a rebound in growth; deferred game revenue provides a solid buffer; and the stock’s valuation remains at historically low levels.

  Weaknesses

  In the short term, substantial AI-related capital expenditures are weighing on reported earnings; the lifecycle of new gaming titles remains relatively subdued; and the broader macroeconomic consumer environment continues to exert downward pressure on advertising revenue and in-game spending.

  Risks

  Macroeconomic risks (credit and retail consumption); fluctuations in user engagement; competition from other internet platforms; and regulatory risks, including antitrust scrutiny.

Key data

• Q1 total revenue196.5 billion yuanYear-on-year growth was 9.1%, slightly below the expected range of RMB 197.6 billion to RMB 199.4 billion.
• Core operating profit (excluding AI)84.4 billion yuanYear-on-year growth was 17.4%, significantly higher than the reported figure of 9.1%.
• Advertising revenue growth rate+19.8%Higher than expected; the previous quarter was 17.5%.
• Enterprise services growth rate+20%Including Tencent Cloud and e-commerce businesses, with significant acceleration.
• Growth rate of deferred revenue in the gaming sector+15.0%This suggests that future game revenue is expected to grow by 15–16%.
• Target PriceHK$780This corresponds to approximately 69% upside, based on a 20x FY+1 PE multiple.

Impact & implications

The research report concludes that Tencent currently trades at a 14x trailing twelve-month (TTM) price-to-earnings ratio, making its valuation attractive. Although increased AI-related spending may exert some margin pressure on the group’s overall earnings in the near term, the company’s robust platform position positions it well to leverage AI for sustained long-term growth. With the rollout of domestically produced computing chips and the expansion of its cloud services in the second half of the year, Tencent’s competitive edge in the B2B and enterprise‑services segments is expected to strengthen further. For investors, the key takeaway is that the current trade-off in profitability is aimed at building competitive moats in the AI era, while the core businesses—advertising and gaming—continue to generate healthy cash flows and demonstrate resilient growth.

Risks

• Macroeconomic Risks: Such as credit tightening or weak retail consumption, which could dampen advertising and gaming expenditures.
• Competitive Risks: Intense competition from other internet platforms in the gaming and advertising sectors.
• Regulatory Risks: Including China’s antitrust regulations and other policy changes.
• User Behavior Risk: Adverse fluctuations in platform user engagement

What to watch

• Progress on Domestic ASIC Chip Deliveries and Tencent Cloud Capital Expenditures in the Second Half of 2026
• The iterative performance of the next-generation AI models to be released later this year
• The pace of improvement in the ad load rate of Video Accounts and the corresponding changes in eCPM.
• The pace at which deferred game revenue is converted into actual revenue