Even as US President Donald Trump's latest tweets about another Chinese company potentially walk back a toughening of trade relations, Morningstar tips these artificial intelligence heavyweights to outperform.

While the US currently leads the artificial intelligence (AI) race, China is fast closing the gap. Beijing's audacious vision for AI dominance is backed by massive infrastructure spending – including building a US$5-billion AI fund and a US$2.1 billion technology park to spur AI innovation.

Money has started flooding into China's thriving start-up industry. The country's AI-focused businesses have attracted a whopping US$4.5 billion between 2012 and 2017, according to a whitepaper produced by Chinese venture capital firm Sinovation Venture.

China's tech heavyweights Baidu, Alibaba and Tencent are spearheading the national AI revolution with staunch government backing. Factors like large amounts of raw data – used to train AI systems – lax regulation, favourable government policies and a population eager to adopt new technologies coalesce to make China a serious contender for the top spot.

These tech leaders are well positioned to be the biggest beneficiaries of China's push for global AI supremacy. Currently trading at a sizeable discount to their Morningstar fair value estimates, these names represent attractive buying opportunities for long-term investors, according to Morningstar equity research.

Baidu Inc

The largest internet search engine in China, Baidu holds a more than 70 per cent share of mobile traffic in the search market. The technology-driven firm, which generates 86 per cent of revenue from online marketing services, has been investing in AI technology such as autonomous cars.

Baidu is going toe to toe with Google in the autonomous vehicles market, backed by its AI-powered self-driving software, Apollo. Much of Baidu's strong fourth-quarter revenue growth was boosted by mobile and artificial intelligence, which led CEO Robin Li to say the company has "built strong momentum by adopting AI-first in our mobile businesses and investing in new AI businesses."

Morningstar equity analyst Chelsey Tam says a Baidu breakthrough in AI-based apps or services, including autonomous driving, could lead to outsize gains, referring to it as "the key upside risk."

Over the past two decades, the search company has accumulated the largest user database in China, which is critical for broader AI innovation and better data analysis, leading to higher advertising efficiency.

Baidu's US$272 share price is a 16 per cent discount to Morningstar's fair value estimate, as at publication date.

Alibaba

The world's largest online and mobile commerce company, Alibaba operates China's most-visited online marketplaces, which accounted for 76 per cent of revenue in 2017, generated through advertising and other merchant data services. The remainder came from digital media, international marketplaces, and cloud computing, which contributed 9 per cent, 8 per cent and 4 per cent of revenue, respectively.

Alibaba has been aggressively pouring capital into artificial intelligence as it buys or backs start-ups doing pioneer work in the field.

"Over the past few years, Alibaba has transitioned from a traditional e-commerce marketplace to a big data-centric conglomerate," says a Morningstar report, adding that "transaction data from its marketplaces, financial services and logistics businesses allow the company to move into cloud computing, media/entertainment and online-to-offline services."

Alibaba's China retail marketplaces generated gross merchandise volume of US$680 billion in 2017, more than Amazon and eBay combined, and accounting for more than 75 per cent of China's online shopping industry, according to data from iResearch.
Its share price of $198.64 is slightly below Morningstar's $210 FVE, as at publication date.

Tencent

Tencent is China's largest internet service platform, connecting users to a variety of web-based services and contents. They include communication and social networking (Weixin/Wechat and QQ), online games, media (news, videos, music and literature) and utilities (app store, mobile security and mobile browser). 

The firm's infrastructure services include payment, security, cloud and artificial intelligence, which create differentiated offerings for businesses.

The internet behemoth – which Morningstar regards as holding a wide moat of competitive advantage – has been aggressively ramping up its AI efforts by establishing dedicated artificial intelligence labs. With the largest social networking platforms in China with active users exceeding 1 billion, "Tencent monetises its social-networking platforms through selling in-game items, virtual items, premium service subscriptions, online advertising, payments, financial products and others," says Morningstar's Tam says in a recent report.

The company holds a 52 per cent revenue share in the Chinese online gaming market. Tencent Games, which include Weixin/Wechat Game Center and QQ Game Center, represents a lucrative way to monetise the voluminous user behaviour data accumulated through various products and services.

Further, with the second largest mobile payment market share of 40 per cent, Tencent's monetisation potential in fintech is substantial. "Through analysing the data and applying artificial intelligence, the advertisers can improve the efficiency of advertisements through targeted marketing, which can lead to higher advertising revenue for Tencent," says Tam, who pegs the stocks fair value at US$82, and projects a strong annual top-line growth of 29 per cent for the next 10 years.

With a share price of $52.35, Tencent was trading at a 37 per cent discount to Morningstar's FVE as at publication date.

More from Morningstar

 

• Keys to a successful small-cap strategy

• 3 undervalued companies worth a second look

• Make better investment decisions with Morningstar Premium | Free 4-week trial

 

This article originally appeared on the website of Morningstar Canada.

Vikram Barhat is a Toronto-based financial writer specialising in investing, personal finance and small business.

© 2018 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782 ("ASXO"). The article is current as at date of publication.