China Merchants Securities International has released a research report indicating that Tencent Holdings (00700) delivered slightly better-than-expected second-quarter results. Growth in its domestic gaming and advertising segments outperformed forecasts. Excluding investments in new AI products, operating profit rose 19% year-on-year, signaling an improvement in the quality of its core business earnings.

On the other hand, the company has outlined four clear AI strategies that support a more aggressive capital expenditure plan. The brokerage suggests that the earnings release driven by AI integration into the core business provides support for these AI investments. It is optimistic about Tencent's AI products and the strength of its ecosystem moat, maintaining a "Accumulate" rating while lowering the price target from HK$632 to HK$620.

The firm has raised its capital expenditure forecasts for Tencent for 2026 and 2027 to 215.7 billion and 260 billion yuan, respectively. Due to higher depreciation expenses, it has reduced its core net profit estimates for 2026 to 2028 by 5% to 9%, projecting core net profit growth rates of 2% and 3% for 2026 and 2027. The brokerage believes that the increased capital expenditure will create some short-term financial pressure for Tencent, but this can be mitigated by improved earnings from its core operations. Furthermore, the AI investments provide clear downside protection.