Summary
Alibaba stock is cheap compared to U.S. tech stocks, with a market cap of just over $200 billion and $25 billion in annual free cash flow.
BABA faces increased competition in the domestic Chinese market due to regulatory changes, but its international commerce segment continues to grow rapidly.
Risks for Alibaba include mixed economic data from China, heightened competition, and ongoing U.S./China tensions.
Jack Ma Michael Loccisano
Alibaba Group Holding $Alibaba(BABA)$ is a stock I've covered for a long time on Seeking Alpha. I haven't been covering it as much lately as I did in the past, because I've said most of what I wanted to say about the company. However, I did add to my BABA position on the stock's most recent dip, as I thought that it had gotten too cheap when it fell to $78.
On June 8th, Alibaba is doing $25 billion in annual free cash flow. It has $75 billion in cash and short term investments. As I wrote in a recent Tweet, the combined amount is enough to buy back more than half the float in three years, if the stock price doesn't change. The point is academic, because such a large buyback would undoubtedly move the price. However, it does go to show that Alibaba shareholders can probably safely expect more buybacks in the future.
A lot of investors appear to be of the opinion that Alibaba has lost its growth permanently. The company's revenue growth was only 2% last quarter, the growth rates were similar in the two quarters prior to that. It may well be that Alibaba's growth will be slower in the future than it was in the past. Indeed, that probably will be the case in the China commerce segment, where Alibaba faces stiff competition from JD $JD.com(JD)$ and PDD Holdings $Pinduoduo Inc.(PDD)$. The international segment is a different story. Last quarter, Alibaba's international commerce segment actually regained its high double digit growth, after several quarters of deceleration. In Q1, that segment grew at 29%, making it BABA's biggest growth driver in the period. If the international commerce segment keeps growing rapidly, then it will become an ever-larger share of the whole, potentially driving significant growth.
Now, that last point needs some clarification, as several of Alibaba's business units are about to be spun off. So far, we know that the Cloud, Freshippo and Cainiao will be spun off to shareholders. In other words, the organization 'Alibaba' as we know it will eventually stop existing, being split up into multiple companies. However, the spin off process will take time; the cloud is the only segment with an IPO planned to occur in the next 12 months. So, it's still worth thinking about Alibaba's "whole firm" growth and profitability.
In this article I will explain why I bought Alibaba's most recent dip, in which it fell to $78. I'll explain the thought process behind my purchase at that level, and the reasons I was happy buying at that level even though I hadn't planned on buying more BABA before the crash. Finally I'll explain why I still think the stock is a decent value today, even though it has rallied 10.2% from the level at which I bought.
Valuation
The main thing Alibaba had going for it when I bought the dip at $78 was a cheap valuation. BABA is one of the cheapest large technology companies in the world. It does $25 billion in annual free cash flow, yet its market cap is just a little over $200 billion. It wouldn't even take 10 years for BABA to buy back its entire float if the stock price didn't change!
Of course, there are reasons why Alibaba stock is cheap. It's based in China, a country perceived to be risky due to U.S./China tensions. It has several competitors, which has impeded its domestic market growth in recent quarters. Finally, it took a $2.8 billion fine in 2021, as a result of China's tech crackdown, and some think that similar regulatory risks could present themselves in the future.
All of these risks result in BABA typically trading at a discount to its U.S.-based peers. At 8th's prices, the NASDAQ-100 index is at 23.72 times earnings. At the same time, Alibaba is trading at:
10.74 times adjusted earnings.
21 times GAAP earnings.
1.75 times sales.
1.5 times book value.
7.4 times operating cash flow.
9.4 times free cash flow.
Compared to U.S. tech stocks, Alibaba stock is quite cheap. In fact, going by some ratios, it's cheap compared to global stocks as a whole. The price/free cash flow ratio, for example, is low in absolute terms. Clearly, Alibaba stock is exposed to certain risks, but is it really so risky that it should trade at half the NASDAQ's earnings multiple indefinitely? In the next section, I'll explore some factors that can shed light on the matter.
Competitive Position
Leaving aside all of the geopolitical factors that I touched on previously, the main risk Alibaba faces today is heightened competition in the domestic Chinese market.
As mentioned previously, Alibaba faces competition in China from JD, PDD Holdings, and a few others. The number of large competitors hasn't changed much in the last few years, but one key factor has:
The regulatory environment.
As a result of China's 2021 tech crackdown, Alibaba can no longer have the "choose one of two" policy, which gave it an advantage over smaller competitors. It has to share links to Tencent $Tencent Holding Ltd.(TCEHY)$ web domains and allow purchases via the WeChat app. It took a $2.8 billion fine for various anticompetitive practices. Basically, China is no longer allowing many practices that BABA once relied on to shore up its competitive position.
To be honest, it looks like there will be more competition in the China domestic market going forward. It's a different story in the international market. Alibaba's only true competitor internationally is PDD Holdings: JD is not actively selling in the U.S. or Europe. JD's international business is mostly focused on imports from non-Chinese markets to China. Shein is a partial competitor, but it only sells clothing, not the full gamut of goods you'd find on Temu or AliExpress. In international markets, Alibaba faces competition from PDD and non-Chinese e-Commerce platforms. However, when you consider that the Chinese shopping apps are mainly focused on low priced goods and "deep discounts," it's not clear that Amazon $Amazon.com(AMZN)$ or Shopify $Shopify(SHOP)$ are competitors there. Alibaba's relationship with AMZN and SHOP is more complementary than competitive: drop shippers buy bulk goods on Alibaba and sell them at a markup on the U.S. platforms. This is very different from AliExpress and Temu. More to the point, Alibaba shares in the success of vendors selling Chinese goods on Amazon, rather than being harmed by them.
Risks and Challenges
As we've seen, Alibaba is a very cheap tech stock with a pretty good competitive position. For my money, it's a buy-I certainly think it was a buy when I grabbed it at $78. Nevertheless, there are many risks and challenges for investors to watch out for here:
Mixed economic data from China. China has been releasing its April and May economic data over the last few weeks, and it has been mixed. On a positive note for Alibaba's domestic operations, retail sales grew 18.4% in April. On a negative note for Alibaba's international operations, exports fell 7.5% in May. It's hard to say what these figures mean for Alibaba's business as a whole. They'd tend to argue that sales will come in pretty strong for Q2, but on the other hand, they might be a bearish signal for the company's international operations. Given the mixed nature of these signals, it would be wise to play it safe with Alibaba, sizing positions appropriately.
Competition. Thanks to China's 2021 regulatory crackdown, Alibaba now faces more competition than ever before. It's not that the number of competitors has increased, but rather that BABA has fewer tools at its disposal to gain market share. "Choose one of two" is out, exclusivity in payment providers is out, and more. So, on the domestic front, Alibaba will have to fight harder to gain market share.
U.S./China tensions. The U.S. and China are at odds over many issues. The tensions between the U.S. and China sometimes have economic consequences. For example, in 2020, then-U.S. President slapped tariffs on $300 billion worth of Chinese goods. More recently, the Biden administration banned the export of various types of chip equipment to China. There is a real risk that this kind of economic tension continues, and investors will want to keep an eye on it.
The risks and challenges above are worth thinking about. Nevertheless, Alibaba is a pretty cheap stock with high margins and a decent competitive position. It's still a pretty good value in this author's opinion.
Source: Seeking Alpha
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