Alibaba: The Market Is Underappreciating The Company's Profitability Improvements

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Alibaba: The Market Is Underappreciating The Company's Profitability Improvements

Seeking Alpha2023-08-28

Alibaba's FY1Q24 revenue and profit beat expectations, riding the wave of strong consumer recovery and travel demand while streamlining its business and improving operating efficiencies.Taobao and ...

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SL1977
·2023-08-29
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BlueBear
·2023-08-28
Last two years journey, make investor shying away
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largest customers.Long-term prospects of the cloud business remain given the low penetration of cloud infrastructure spend, along with the long-term AI opportunity for Alibaba Cloud.Alibaba continued to repurchase shares in the quarter and I continue to see its business restructuring as near-term catalysts given the unlocking of value for shareholders.maybefalse/iStock Unreleased via Getty ImagesAlibaba (NYSE:BABA) reported its FY1Q24 or June quarter which was a beat on multiple fronts.Let's dive right into the quarter.Revenue and Profit Solid BeatAlibaba reported its June quarter based on its new corporate structure, highlighting the performance of its six major business groups.Revenue mix and growth of each of the six major business groups can be seen below.In the June quarter, Taobao and Tmall Group grew 12% from the prior year to Rmb115 billion, while Alibaba International Digital Commerce Group posted strong growth of 41% from the prior quarter to Rmb22 billion.Local Services Group grew 30% from the prior year to Rmb14.5 billion, while Cainiao Smart Logistics Network grew 34% from the prior year to Rmb23 billion.Cloud Intelligence Group grew just 4% from the prior year to Rmb25 billion while the Digital Media and Entertainment Group grew 36% from the prior year to Rmb5.4 billion.Overall revenues grew by 14% from the prior year to Rmb234 billion.This is 5% above consensus expectations, which is a decent beat from Alibaba in my view.Financial highlights (Alibaba)Net income grew by 43% from the prior year to Rmb45 billion, ahead of consensus by a solid 16%.This was largely driven by better gross profit margins, lower research and development expenses as well as G&A expenses while sales and marketing was largely in-line.As a result, diluted earnings per share came in at Rmb17.37 and beat consensus expectations by 23%.Free cash flows grew 76% from the prior year to Rmb39 billion, translating to 17% free cash flow margins, while total adjusted EBITA grew 27% to Rmb 52 billion, translating to 22% adjusted EBITA margins.I highlight the breakdown of adjusted EBITIDA by business groups below:Taobao and Tmall Group EBITA margin down slightly from 44% in FY1Q23 to 43% in FY1Q24.Alibaba International Digital Commerce Group EBITA margin improved from -8.8% in FY1Q23 to -1.9% in FY1Q24.Local Services Group EBITA margin improved from -25.5% in FY1Q23 to -13.7% in FY1Q24.Cainiao Smart Logistics Network EBITA margin improved from -1.1% in FY1Q23 to +3.8% in FY1Q24.Cloud Intelligence Group EBITA margin also improved from 0.8% in FY1Q23 to 1.5% in FY1Q24.Digital Media and Entertainment Group EBITA margin achieved breakeven in the quarter, with improvement from -23% in FY1Q23 to 1% in FY1Q24.I will now go through each individual segment and share my thoughts on them.Taobao and Tmall GroupAlibaba commented that they are seeing a gradual recovery in the Chinese economy as the government has made many efforts to stimulate economic growth and drive consumption.What are Alibaba's strategies for the Taobao and Tmall Group?It has three key strategies. Firstly, Alibaba aims to pursue growth in user scale. Secondly, Alibaba wants to develop and construct a vibrant ecosystem. Thirdly, it hopes to realize technology driven innovation.With continued investment into users and user growth, this should lead to continued merchant growth and in turn, help drive revenues of the Taobao and Tmall Group. In turn, this creates a flywheel effect where the higher revenues can then be reinvested into the business.What were the reasons for solid June quarter in the Taobao and Tmall Group?There were a few reasons that drove the strong performance in the June quarter.Firstly, the macroeconomic environment improved in the quarter and consumption started to recover. In particular, the higher penetration of online retail purchasing within the retail space served as an additional tailwind for the company.Secondly, Alibaba is starting to see the rewards of earlier investments in lower tier cities and its investments in the value-for-money battle. The company saw an increasing number of new users coming from younger individuals, lower tier cities and even the elderly.The emphasis of management this earnings call was that Alibaba will focus on the long-term development of its business and continue to build its business by investing in more capabilities.As a result, for the Taobao and Tmall Group, management expects that in the next three-year period, Alibaba will continue to invest in user scale, optimize user experience, help merchants grow business, and improve services to merchants.Alibaba International Digital Commerce GroupThe Alibaba International Digital Commerce Group showed robust growth, growing 41% from the prior year while adjusted EBITA loss narrowed from -8.8% from the prior year to -1.9% in the quarter.AliExpress saw robust order growth as a result of more transacting users and an improved customer experience. For example, AliExpress's Choice continued to help consumers upgrade their experience by providing price competitiveness and better service standards. This in turn resulted in stronger user retention rate and increased frequency of purchases.Lazada saw double digit growth in orders from the prior year in the June quarter, as the business saw the monetization rate improving due to more value added services offered to merchants. Unit economics of Lazada improved from the prior year as a result of the stronger monetization and improvements in operating efficiency.Lastly, for Trendyol, the business delivered strong order growth as a result of both e-commerce and local consumer services business and with the strong revenue growth and operating efficiency improving, this was actually the first quarter in which Trendyol achieved positive operating results.Cloud Intelligence GroupThe Cloud Intelligence Group segment revenue grew 4% from the prior year while adjusted EBITA remained positive in the June quarter at 1.5%. From a customer base perspective, growth was driven by the auto, electric power, education, and financial services sectors, while from a product perspective, growth was driven by storage, networks and AI computing related products during the June quarter.Management shared on the earnings call that the cloud infrastructure spend as a percentage of the total IT infrastructure remains at a low level in China when compared to the United States.This does lead to a huge potential for cloud infrastructure penetration to increase in the long-term in my view, and why I am long Alibaba given its leadership in the space.On top of that, with the current focus on AI, this helps to accelerate cloud infrastructure spend as more companies upgrade their services and applications as they require high performance computing power to support their operations. As a result, I can see this as a newer growth engine for Alibaba Cloud, although this will remain a long-term opportunity.Take note that management thinks that it will take some time in the near-term for customers to digest the impact of the decline in cloud computing demand after the pandemic, along with the decline from one of its top customers, which I have talked about multiple times before.While tackling this near-term environment, management will implement some proactive measures to focus on high quality public cloud growth.Having the right sales structure and customer profile will enable Alibaba Cloud to be in a good position to drive long-term sustainable growth as it enables customers from a wide range of industries to succeed with their own digital transformation journeys.When thinking about the AI opportunity, Alibaba thinks that the best way for the company to monetize this is to have these AI companies run their models on the Alibaba Cloud platform, as a result of the platform's high performance and low cost computing power.In addition, Alibaba will also help its customer to build customized applications for their own industries by deploying its own foundational model in Alibaba Cloud.As a result of the rapid development in AI-generated content, Alibaba Cloud developed an open-source platform ModelScope, which has more than 45 million downloads over 1,000 AI models as of July 2023.Management is seeing many companies in China currently working on large language models and the team at Alibaba continues to be committed to investing in AI as it represents an opportunity for the company to develop innovation and technology that generates strong future commercial value.Local Services GroupThe 30% growth of the Local Services Group revenue in June quarter was due to strong GMV growth in Ele.me and the rapid order growth of Amap.Also, the narrowing of adjusted EBITIDA losses in the quarter was a result of the continued narrowing of losses driven by Ele.me's order growth and the positive unit economics per order as well as rapid order growth of Amap driven by strong market demand.The strong GMV growth in Ele.me was a result of strong order growth, contributed by consumer demand improving, growing number of active capacity as well as delivery capacity improvements in the quarter. As a result, Ele.me's unit economics per order continued to be positive and order density continued to improve.For Amap, daily active users and the to-destination services expanded in the quarter, largely due to a recovery in travel and commuting in the quarter. In addition, Amap released new product features in the June quarter and its market share in map navigation services continued to expand.Digital Media Entertainment Business GroupThis was the first profitable quarter for the Digital Media Entertainment business group, with revenue growing at 36% from the prior year and segment EBITA coming in at Rmb63 million for the June quarter.The strong growth and profitability was a result of the increased growth in subscription revenue, the higher revenue contribution from Damai and Taopiaopiao which benefited from recovery of offline entertainment, as well as the Alibaba Pictures' launch of several blockbusters such as movie Lost In The Stars and the robust China box office demand during the quarter.Capital ManagementAlibaba repurchased 35.6 million shares for $3.1 billion in the June quarter under the share repurchase program.The remaining authorization for the share repurchase program stands at $16.3 billion at the end of the June quarter, and this program is effective through March 2025.As highlighted earlier, Alibaba generated Rmb39 billion of free cash flows during the June quarter, up 76% from the prior year.Management shared that under the new governance framework, they will continue to strengthen the capital management of the company and improve shareholder return through continued share repurchase activities.On top of that, as I am expecting, management shared that there are several capital market projects that are still underway, which will lead to unlocking of value for shareholders.ValuationAs can be seen below, I used a sum-of-the-parts valuation for Alibaba.My numbers here are conservative in my view, as we have seen Local Services Group and International Digital Commerce Group grow more robustly than expected, while almost all of the business groups saw stronger profitability as the company continued to improve efficiency.Alibaba SOTP (Author generated)ConclusionThis quarter was a solid one for Alibaba.The company benefited from the consumer demand recovery and increased commuting and traveling in the region.In addition, I think that management is executing well, as operating efficiency improvements continued in the quarter, as evident from the stronger adjusted EBITA margin profiles of multiple segments.I continue to be positive about the fundamentals of Alibaba given that there are near-term restructuring catalysts in the form of business unit spin offs that will unlock value for shareholders.The strong progress on the profitability front on multiple businesses within Alibaba shows the strong focus management has on costs and likely a key contributor to its near-term restructuring efforts as it looks to unlock shareholder value.Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. 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