Alibaba: I Keep Disagreeing With The Crowd

seekingalpha07-23

BABA stock now enjoys bullish sentiment from both Wall Street and Seeking Alpha analysts.Two of the key pillars behind the bullish sentiment are its low P/E and regulatory easing in China.However, the...

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DreamZ85
07-23
DreamZ85
O seeking alpha again. Time to load up on baba. The last when they mention SEA is not going to make it suddenly the stock shoot up by at least 20%

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Andrii Yalanskyi/iStock via Getty ImagesBABA stock is now loved by Wall Street I last covered Alibaba Group Holding Limited  a little more than a month ago. More specifically, on June 13, 2024, I published an article titled \"Alibaba: Don't Buy Fair Businesses At Wonderful Prices\" on Seeking Alpha . 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A total of 45 Wall Street analysts wrote about BABA in the last 30 days, and 31 recommended a strong buy. In other words, almost 69% of the analysts ranked it as a strong buy. The ratings from Seeking Alpha writers are not as positive as Wall Street, but the sentiment is still firmly in bullish territory. As seen, over the past 30 days, a total of 31 Seeking Alpha authors covered the stock, 11 recommended a strong buy (35.5%) and another six recommended a buy (19%).In the remainder of this article, I will explain why I keep disagreeing with the crowd and maintain my rating for the stock at a Hold. The analysis in my last article focused on its valuation (especially relative to its growth potential). In this article, I will examine the thesis from a different angle by looking at its competitive position and profitability.Seeking AlphaBABA stock is now in a weakened competitive positionBesides the cheap valuation, another key point many bulls often quote is that there are many signs indicating that China’s crackdown on tech giants is toward an end (or has already ended). Such regulatory easing is therefore bullish for BABA.First, the reading of these signs is open to interpretation, in my view. Furthermore, political issues can be fluid, change quickly, and are ultimately unpredictable, in my view. Second and more importantly, even if the crack is over as many bulls believe, I don’t think BABA is in the same strategic position as it was before the crackdown started. According to Yahoo data, over the course of the crackdown, Alibaba’s Taobao and Tmall platforms have seen their market share plunging from an absolute dominance of ~80% in 2017 to about 37% in 2023.At the same time, BABA's profitability deteriorated severely during this period of time, as you can see from the chart below. In this chart, I relied on ROCE (return on capital employed, the most important profitability metric in my mind) to illustrate the decline in profitability. Details of the calculation of ROCE are summarized in my earlier writings. In the chart below, I consider the following items to be capital actually employed. All numbers used to compute its 2024 ROCE were taken from its latest balance sheet: 1) payables (about $17.66 billion), receivables (about $9.54 billion), inventory ($3.52 billion), and net Property, Plant, and Equipment ($36.3 billion). The ROCE is based on operating cash flow and for its 2024 number, I used the TTM operating cash flow ($25.2 billion). With these inputs, its 2024 ROCE turned out to be about 69% - a quite respectable level to be sure. However, it's nowhere near the levels it used to enjoy (and justify its premium P/E) before the crackdown. As seen, BABA’s ROCE was at astronomical levels above 200% between 2014 and 2017. Over the course of the regulating tightening (in combination with heightened competition, slowdown of China's overall economy, etc.), BABA’s ROCE suffered tremendously. Its current level of 69% is not only a far cry from its pre-crackdown days but also substantially below its five-year average of 95% (i.e., during the period of the crackdown) and noticeable below key competitors such as JD.com, Inc. (JD).AuthorBABA stock: Competitive landscape has changedBesides the profitability pressure, another factor to consider is that the competition landscape has also changed over the past few years. Besides old rivals like JD.com, the rise of new entrants has caused tectonic shifts in the landscape in my view.A notable example is the rise of PDD Holdings Inc. (PDD). From first-hand observation, I can tell you that the stuff my wife orders from TEMU has grown exponentially since PDD launched its overseas service. Indeed, PDD differentiates itself from BABA in several ways and I think each one is a real threat. The top one in my mind is the overpowering combination of social media with e-commerce. PDD leverages social media integration and gamification to drive viral product sharing and incentivize purchases within its platform. This strategy fosters a strong community aspect. In contrast, BABA leans on a more traditional e-commerce model which potentially misses out on key customer segments (younger, price-sensitive demographics, etc.) that PDD capitalizes on, but also fails to tap into the social commerce boom. Such competitive risks are not only reflected in BABA’s much slower active user growth compared to PDD but also directly in the margins as you can see from the chart below. The next chart shows that PDD has had a significantly higher operating margin than BABA over the last four years since it turned profitable. PDD’s operating margin is around 29.92% currently while BABA’s operating margin is much lower at 6.65%.Seeking AlphaBABA stock: Cainiao’s failed IPO and other risksAnother key uncertainty involves BABA’s recent withdrawal of its Cainiao IPO. This development came on the heels of several other derailed plans for segment spinoffs. The failure of the restructuring plan is interpreted in a negative by the market and an example comment from Barron’s is quoted below:BABA has canceled the planned initial public offering of its Cainiao smart logistics division, effectively dealing a death blow to its year-old bid to unlock value for shareholders through restructuring the beaten-down Chinese tech giant.I tend to agree with such a negative interpretation. Besides failing to unlock shareholder value, I also see a couple of other potential damages. A failed IPO can be seen as a sign that the company is not performing well, which could damage Alibaba's reputation and investor confidence. Moreover, Cainiao is a key part of Alibaba's logistics network, and its growth is essential for the overall growth of the company. If Cainiao is unable to raise capital, it may not be able to expand as quickly as planned.Finally, trading at a single-digit P/E, BABA’s valuation is attractive in absolute terms as the bulls often argue. However, the valuation is not that attractive in my view in relative terms. As seen, in the next chart below, JD trades at a lower P/E (7.76x FY1 P/E vs. BABA’s 9.12x) despite its higher ROCE as analyzed above. PDD trades at slightly higher P/E (about 11.3x FY P/E) but its recent growth rates are about 10 times higher than BABA.Seeking AlphaUpside risks and final thoughtsThe upside risks are mostly longer-term oriented in my view. I envision the secular growth of several segments to act as a tailwind for BABA in the long run. First and foremost, I expect the e-commerce revolution in China to march forward relentlessly. According to International Trade Administration data (see the chart below):China is the largest e-commerce market globally, generating almost 50 percent of the world’s transactions. According to eMarketer, China’s online retail transactions reached more than 710 million digital buyers, and transactions reached $2.29 trillion in 2020, with forecasts to reach $3.56 trillion by 2024. In 2021, China became the largest market for e-commerce with a revenue of $1.5 trillion, placing it ahead of the United States.Second, I expect BABA’s Cloud Intelligence Group to contribute more meaningfully to the top line in the years to come as global enterprises continue to adopt cloud and cyber security services. Finally, the artificial intelligence arena has just started and holds significant long-term upside for BABA and other e-commerce players.However, in the near term, I don’t share the bullish sentiment surrounding BABA. I see a very uncertain return profile for the company in the next few years. The seemingly low P/E does not fully compensate for the uncertain growth curve (the focus of my last article). In addition, as argued in this article, even if the regulatory tightening is over, the deterioration of profitability and change in the competitive landscape are too large for BABA to reverse anytime soon – if at all.eMarketerEditor'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.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"analysis","news_rank":0,"symbols":[],"gpt_button":0},"commentList":[{"id":330639469187168,"gmtCreate":1721728437983,"gmtModify":1721728442659,"author":{"id":"3577569919471507","authorId":"3577569919471507","name":"DreamZ85","avatar":"https://static.tigerbbs.com/4f88a546cd1787f83e30c21f07ed2b3a","vip":1,"crmLevel":7,"crmLevelSwitch":0,"idStr":"3577569919471507","authorIdStr":"3577569919471507"},"htmlText":"O seeking alpha again. 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