Alibaba Stock: Nothing Happens By Chance Before Earnings (NYSE:BABA)

Introduction

My first 4 articles on Alibaba Group (NYSE:BABA) stock (coverage initiated in November 2021) were bearish. However, I later revised my rating to ‘Neutral’, considering the company’s undervaluation, a trend evident since December 2021, based on my calculations. Despite the prevailing positive sentiment regarding factors such as the Chinese market’s growth prospects and Alibaba’s margin of safety, the company’s stock has consistently declined. Since my last ‘Neutral’ recommendation recommending investors to steer clear of BABA, the stock has experienced a 4.52% decrease, underperforming the broader market represented by the S&P 500 index (SPY) (SP500) by around 1326 basis points (total returns):

Today, I wish to present an alternative perspective that deviates somewhat from my previous convictions.

I still think it’s risky to invest in Chinese assets. However, given some recent events and “coincidental” things happening, I’m feeling less negative today regarding buying Alibaba stock for the short term. I have a feeling that Alibaba might do better than expected in its upcoming quarterly report on February 7, 2024, according to Seeking Alpha.

Why Do I Think So?

Yes, I’m cautious about the Chinese stock market because it operates differently from what Western investors are used to. The unique structuring of Chinese companies, whose depositary receipts are actively traded in the U.S. market, poses significant regulatory risks, often overlooked by many Western investors. I believe the Chinese market operates under somewhat different rules due to the authoritarianism of the ruling Communist Party, limiting the market freedoms familiar to Western investors. The case of Jack Ma, where expressing dissatisfaction led to a significant impact on Alibaba’s stock, highlights the influence of this authoritarian system. And Western investors, seeking explanations for their poor investment performance, often looked in the wrong places when trying to understand the market dynamics.

So despite considering various arguments that Alibaba’s business may improve in the future, I can’t shake the belief that long-term investment in the current Chinese market is not feasible until issues related to authoritarianism and the unique status of depositary receipts for Chinese shares are resolved. Therefore, in today’s article, while I explore the BABA stock with a relatively positive outlook, I still cannot recommend it as a ‘Buy’ to you, my readers. Hence no upgrade for BABA today.

What positive do I see in BABA to date?

Well, on January 23 we found out that Alibaba’s co-founders Jack Ma and Joe Tsai bought $50 million, and $150 million of the company’s stock, respectively, through their family investment funds in Q4 FY2023. This news created quite a buzz, leading to a 7.85% increase in BABA on the first day. However, it seems that those who had purchased the stock at way higher prices saw this rip as an opportunity to get out, resulting in a subsequent drop by several hundred basis points after that initial spike.

Alibaba itself bought back $9.5 billion worth of stock last year, reducing its share count by >3%, as WSJ reports, but it didn’t change the matter for BABA’s value creation.

Notably, Jack Ma’s family trust sold 10 million depositary receipts, amounting to $871 million, in November 2023. So the recent purchases can be seen as a partial restoration of their position, though not as substantial as before.

Renowned investor Peter Lynch once stated that insiders sell their stocks for various reasons, but they only buy when they believe the price will rise. This is crucial in understanding my current stance on Alibaba.

I don’t view the announcement of Jack Ma and Joe Tsai purchasing BABA stock a few weeks before the Q4 FY2023 earnings release as a mere coincidence. What’s significant is not just Jack Ma entering a position but the substantial acquisition by Joe Tsai – even for him, $150 million is a considerable amount of money. And he’s still in the company’s leadership position as a Chairman. This move, made just two weeks before the report, leads to several logical conclusions.

We recall the reasons behind Alibaba’s 9.14% stock price drop immediately after releasing its Q3 2023 results. Mr. Market responded negatively to the company’s decision not to spin off Alibaba Cloud from its structure at that time. Personally, what I also found concerning was the relatively slow pace of recovery and growth, along with the struggling margins of individual business segments. As the company has not yet reported for the new quarter, the data from that period now appear outdated, and it seems the market has already priced in all that information – that’s why BABA has fallen by another 7.5% since then.

What if this time the management’s purchases are not a coincidence? What if Alibaba managed to achieve more significant growth in business margins in the 3rd quarter of 2023? If this turns out to be true, then I wouldn’t be surprised to witness a solid recovery rally in Alibaba’s stock price after the report is published.

Even if we don’t get actually strong results for Q4, let’s consider potential comments from the management because it also matters a lot. Why would top executives like Joe Tsai invest such a significant amount in BABA if they weren’t expecting positive remarks about the company’s future on the earnings call? One might say that most of the time earnings calls sound the same ‘positive’. But why they didn’t buy the stock then? Maybe Alibaba has something new to announce that the market doesn’t anticipate, leading to unexpected growth and rewarding Alibaba shareholders.

The Verdict

Despite my initial disclaimer about not upgrading my ‘Neutral’ rating on Alibaba, my current journalistic analysis (so to speak) leads me to a relatively positive short-term outlook for BABA after exploring the reasons behind top management actively purchasing shares right before the Q4 report release.

Despite a modest projected EPS growth rate (CAGR) of around 3.64% over the next 6 years (Seeking Alpha Premium data), Alibaba stock appears undervalued to me based on standard conventional valuation ratios. With a significant FCF yield of ~ 16.5%, I can’t see where this metric increase should expand more. The ongoing buyback of shares will likely play a decisive role, though pinpointing when this bearish trend concludes remains uncertain.

The upcoming report might shed more light, and I dare to speculate that Alibaba could either surpass current modest market expectations or present innovative ideas on the earnings call, particularly in the realm of artificial intelligence. While the exact outcome remains uncertain, recent management actions, such as the strategic purchase of the stock right before the Q4 report, suggest intentional decision-making rather than happenstance.

If you lean towards being more favorable to Chinese assets, you may consider treating my verbal speculation as an actual course of action, but proceed with caution and at your own risk. Do your own due diligence first!

Thanks for reading!

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.