Alibaba Stock: It’s Time To Be Greedy (NYSE:BABA)

My Thesis

Alibaba Group (NYSE:BABA), one of the biggest Chinese and international e-commerce platforms, faces challenges from increased competition, political pressures, and macroeconomic softness, contributing to its underperformance in recent years. The stock is now trading more than 78% off its 2020 highs:

I believe this decline – its scale in particular – can no longer be explained by the company’s weak fundamentals, which are likely to continue to reverse after the COVID crisis. I’m taking a risk when I write this, but the BABA stock looks like a classic contrarian ‘Buy’ as it has a pretty comfortable margin of safety and growth prospects from its developed projects.

My Reasoning

First off, let me jump right to the recent financials of Alibaba.

The company’s fiscal 2Q FY2024 results revealed a 9% YoY increase in revenue to RMB 224.7 billion. That translated to ~$30.8 billion (+6% YoY), falling short of the expected $31.05 billion. Non-GAAP earnings per ADS were $2.14, surpassing the consensus estimate of $2.09. Despite a positive response to the earnings beat, the company surprised investors by announcing it would not spin off its cloud business. Alibaba cited recent US export control expansions, restricting the export of advanced computing chips and semiconductor manufacturing equipment to China, as a major factor affecting its Cloud Intelligence Group’s operations and financial outlook. As a result, the stock fell sharply post-earnings release and commentary.

However, I believe that in reality, not everything is as bad as it seems at first glance. I suggest one pays special attention to Alibaba’s segment dynamics in Q2.

In case you don’t know, Alibaba Group recently operated in 4 segments: Core Commerce, Cloud Computing, Digital Media & Entertainment, and Innovation Initiatives. But now they report results for 6 separate units:

In Q2 FY2024 the Taobao & Tmall Group (Core Commerce) demonstrated resilience with a +3% YoY growth in Customer Management Revenue (CMR), surpassing the modest decline in Gross Merchandise Volume (GMV). Merchants’ continued investment in advertising, aided by Taobao-Tmall’s ad-tech upgrade, drove improved merchant ROI and enhanced customer engagement. Despite the positive CMR growth, the group’s EBITA increased by +3% to RMB 47.1 billion, resulting in a slight EBITA margin decline to 48.2% from 48.7% a year ago. This decline was attributed to ongoing investments in content and a strategy emphasizing price competitiveness, according to the management.

Alibaba’s Cloud segment faced challenges, recording a modest +2.3% YoY growth in revenue. However, the strategic reduction in lower-margin project-based contract revenue streams contributed to a healthier margin, boosting the EBITA margin to 5.1% from 1.6% in the same quarter last year. The decision to terminate the full spin-off of Alibaba Cloud highlighted its ongoing importance to the company’s strategy, focusing on higher-margin public cloud revenue growth with an emphasis on AI cloud computing.

Alibaba International Digital Commerce Group experienced robust growth, with a remarkable +53% YoY increase in revenue to RMB 24.5 billion. This growth was driven by a combination of retail order growth (+28% YoY) and solid performance across platforms such as Lazada, AliExpress, and Trendyol. Improvement in monetization contributed to an adjusted EBITA of RMB -384 million, reflecting a positive turnaround from RMB -748 million in the same quarter last year.

The Local Services Group demonstrated positive momentum, with a +16% YoY growth in revenue to RMB 15.6 billion. The group also narrowed its adjusted EBITA loss YoY to RMB -2.6 billion. This improvement was attributed to nearly 20% YoY growth in order volume and increased active customers. The positive performance of Ele.me and Amap contributed to the growth in the Local Services Group.

Based on the latest quarterly results of the company’s divisions, I do not see any clearly pronounced negative aspects. Yes, investors didn’t get the cloud spin-off, but then again, one can’t say that management left everything as it was before. I think that the termination of the full spin-off will not diminish its strategic importance for Alibaba. The focus will shift to higher-margin revenue growth in the public cloud, with a focus on AI cloud computing. Goldman Sachs [November 2023, proprietary source] expects Alibaba Cloud revenue growth of 2-4% for 3Q and 4Q FY2024, with a reduction in revenue from project-based contracts. The analysts believe that the launch of “Wanxiangtai Unbounded” and the “return to Taobao” strategy could further drive growth.

Although Alibaba’s plans to focus its operational growth on higher-margin initiatives have only just begun, the company is already on track to return its free cash flow to pre-COVID levels.

Given the recent positive developments in the still loss-making International Digital Commerce Group, I expect BABA to post margin expansion in the calendar 2024 year despite the challenges and skepticism of many market participants. According to YCharts, Alibaba’s revenue growth rate next year is expected to be higher than its EBITDA growth rate over the same period, i.e. the opposite is expected, namely a decline in margin, despite management’s obvious attempts to achieve the opposite.

In general, I see an obvious discrepancy between market expectations. Wall Street consensus estimates point to earnings per share growth over the next 6 years at a CAGR of only 3.5%. Historically, Alibaba’s EPS has grown at a CAGR of around 14.3% since 2014 (including TTM data). At the same time, investments in various high-growth projects such as Lazard showed a tendency to break even only in the past few quarters. That said, going forward, it would probably be reasonable to expect the company’s international business to transition to positive operating profit, which in turn would remove the headwind of EBITA growth.

But even if we assume that Wall Street is right and EPS will grow quite slowly over the next few years. The company has started to actively buy its shares from the market, albeit not to the extent that would satisfy current shareholders. But this creates a discrepancy: with stable positive EPS and FCF numbers, which even the consensus does not doubt, the company has the ability to continue buying its shares from the market as actively as it does today. And perhaps even more actively, we shall see. On this basis, I see only one course for the stock price going forward:

Against the backdrop of the existing discrepancy between the share price performance and the company’s business performance, we also see a very comfortable margin of safety: BABA stock has never been as cheap as it is today, considering the FCF yield and most other valuation metrics.

And at the same time, we see “fear on the street” screaming that Chinese stocks are uninvestable. Yes, this is definitely a risk that one must always be aware of. But given the balance of power described above, I think investors should recall one famous saying, part of which I have included in the title of this article.

Risks To My Thesis

Investing in Alibaba stock comes with several risks that investors should carefully consider.

One significant risk is the potential for lower-than-expected GMV growth, which may be influenced by macroeconomic factors or increased competition. The dynamics of the retail market in China and the company’s ability to monetize its operations pose additional risks, especially if monetization in China retail lags behind expectations.

Also, the company’s focus on reorganization, while potentially beneficial for improving the execution of disparate businesses, introduces the risk of distraction and challenges. The sheer size of Alibaba raises concerns that the reorganization process could enable more focused competitors to gain market share. Additionally, the departure of Jack Ma, a key figure closely identified with the company, and the shift away from his integrated approach to business pose uncertainties.

Furthermore, the controlled economy of the People’s Republic of China introduces regulatory uncertainties, and the company is subject to numerous regulations. The long-term risks associated with regulatory developments, especially in the context of ongoing global trade tensions, could impact Alibaba’s business operations and growth trajectory.

So all interested investors need to carefully assess these risks before making any investment decisions regarding Alibaba.

Your Takeaway

The Alibaba stock is clearly not a risk-free idea. Its price chart also looks pretty ugly to anyone interested in technical analysis:

But if you look at many fundamental factors, things turn out not to be so bad. Almost all of the company’s divisions showed resilience in the last quarter and, most importantly, each of them has some prospects to increase the consolidated EBITA margin, which is still far from consensus. But even with the margin BABA has now, the company earns more than 16% of market capitalization in FCF. According to A.J. Button’s calculations, if you add FCF and cash balance together, Alibaba only needs about 4 years to buy back all its stock – that’s insanely fast. Therefore, BABA is highly undervalued by the market, which all market participants are aware of. However, I believe that it is margin expansion that will become a catalyst that will turn the stock around. Therefore, I suggest being greedy this time.

Good luck with your investments!

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.