2023-08-15 16:32:01 ET
Summary
- Alibaba reported double-digit growth rates again and all six business segments contributed to top line growth.
- The stock remains deeply undervalued in my opinion - even when calculating with rather moderate growth assumptions.
- But the high debt levels, the high youth unemployment and trouble in real estate should make us cautious about China in the foreseeable future.
- However, at this point, a lot of negativity is already priced in for Alibaba.
Alibaba Group Holding Limited ( BABA ) is continuing to be a disappointment – especially the stock. When trying to look for a positive side, we can argue that the stock increased 65% since the bottom in October 2022 – certainly a strong performance. But on the other hand, the stock is still trading 70% below its previous all-time high and many people – including myself – are probably still in the red with their Alibaba investment.
Since I started covering Alibaba about two years ago, I have always been bullish about the business and the stock. When my first article was published, Alibaba was still trading for $220, and although I remain confident that Alibaba was undervalued at that point as a long-term investment, I should have been able to see the writing on the wall. Now at least three of my articles and bullish calls were correct and an investment at these points in time would have made money. And this article will hopefully line up among bullish calls that were correct in the long term.
Strong Results
At this point, we can certainly see an improving fundamental picture for Alibaba. And another positive piece of news was the last quarterly earnings release. For starters, Alibaba did beat expectations and non-GAAP earnings per share exceeded expectations by $0.39 and revenue did also beat by $1.08 billion.
But Alibaba did not only beat expectations, it also seems like the company can finally return on the path of growth. Revenue increased 13.9% year-over-year from RMB 205,555 million in Q1/23 to 234,156 million in Q1/24. Income from operations increased from RMB 24,943 million in the same quarter last year to RMB 42,490 million this quarter – resulting in 70.3% year-over-year growth. And finally, diluted earnings per share increased from RMB 1.06 in Q1/23 to RMB 1.66 in Q1/24 – an increase of 56.6% year-over-year.
Non-GAAP diluted earnings per share increased 47.6% year-over-year and finally, free cash flow increased 76.3% year-over-year from RMB 22,173 million in the same quarter last year to RMB 39,089 million this quarter.
Business Segments and Strategic Updates
And starting with the previous quarter (which ended June 30, 2023), Alibaba implemented its new organization structure (we already mentioned in our previous article ). Alibaba is now a holding company of six major business groups (and some other businesses) and each business is operating with a high degree of independence.
One can speculate that Alibaba mostly implemented the new organizational structure to please the Chinese government and regulators as the huge technology giant was probably a thorn in the flesh of Chinese leadership. But one can argue that breaking up the business in six businesses that operate with high independence could be a major tailwind for the business. Especially for recently covered businesses like Constellation Software ( CNSWF ) or Markel Group ( MKL ), the high level of independence was a major asset for the business and often seen as reason for the outperformance of these companies. I know that we can’t really compare Constellation Software and Alibaba, but it is a point worth mentioning.
When looking at the six business segments, each one contributed to revenue growth – and while the cloud business grew only in the low single digits, every other business segment increased revenue in the double digits. In the following sections, we are looking at some business segments in more detail.
Almost half of revenue is generated by the Taobao and Tmall Group which generated RMB 114,953 million in revenue and basically all the operating income (or adjusted EBITDA) of the holding company. Without much doubt this is the most important segment for Alibaba right now.
And Alibaba is especially focusing on growing its Taobao app. Since April the average number of DAUs each month has grown at least 6% year-over-year and in July 2023 the growth was over 7%. According to Alibaba, the 6.18 shopping festival was also a success that generated solid growth in order volume and average order value (however, I could not find detailed numbers).
Another segment analysts and investors are looking closely at is the Cloud Intelligence Group as major growth expectations lie on its shoulders. First, the segment increased revenue about 4% YoY to RMB 25,123 million and the segment was profitable again and more than doubled the adjusted EBITDA to RMB 387 million. And although the segment was growing, this was rather disappointing for most and it was often pointed out that Alibaba seems not to be able to keep up with competitors in the United States (companies like Microsoft Corporation ( MSFT ), Amazon.com, Inc. ( AMZN ) or Alphabet Inc. ( GOOG ) (GOOGL)).
During the earnings call , Daniel Zhang commented on the rather disappointing growth rates:
During the quarter, Alibaba Cloud revenue grew 4% year-over-year. The growth rate was negatively impacted by the normalization of CDN demand as usage of video streaming, remote working and remote learning paying down when offline activities resumed after a measures were lifted. The growth rate was also partially impacted by revenue decline from a top customer.
And when looking at the results in the last few years, we certainly can see growth slowing down and in fiscal 2023, growth was only 4%.
2020 | 2021 | 2022 | 2023 | |
Revenue | RMB 40,016 | RMB 60,120 | RMB 74,568 | RMB 77,203 |
Growth | 62% YoY | 50% YoY | 24% YoY | 4% YoY |
Nevertheless, I remain confident about the cloud business and as I have argued in a previous Tencent ( TCEHY ) article, the cloud business in China has long-term growth potential.
Also worth mentioning is the strong revenue growth of 36% of the Digital Media and Entertainment Group , that was struggling in the past. The Alibaba International Digital Commerce Group also grew its revenue 41% year-over-year and as international expansion might be one way for Alibaba to continue growing with a high pace, this is good news for investors.
Intrinsic Value Calculation
Alibaba still seems extremely cheap – not only when seeing several business segments reporting strong revenue growth rates again, but also when looking at the price-earnings ratio. Alibaba is trading for 20.85 times earnings. And although a P/E ratio of 21 is not extremely cheap, it is clearly below the earnings multiples of the last few quarters and below the average of the last five years (P/E ratio was 35.44 on average).
But for a business growing in the double digits, a valuation multiple of 20 seems at least reasonable – or could also be seen as rather cheap. And especially the way more important price-free-cash-flow ratio is absurd for a business like Alibaba. We can point out that Alibaba has always been trading for rather low P/FCF ratios in the last five years (with the average being 17.50) but a single digit valuation multiple is unreasonable for every business that is not in a phase of relentless decline. And Alibaba is currently trading for 8.19 times free cash flow, which is extremely cheap - especially when compared to Amazon, but also when comparing to other major technology companies in China.
The discrepancy between the stock price performance and the fundamental performance of Alibaba – leading to extremely low valuation multiples can also be illustrated. When looking at the performance in the last five years, the stock declined about 47% while revenue increased 171% in the same timeframe. Although the bottom line did not keep up with top line growth, earnings per share increased 32% and free cash flow increased 48%.
And the fact that the stock price is not reflective of the fundamental business also becomes obvious when using a discount cash flow calculation. While a discount cash flow calculation usually enables us to come up with a clear intrinsic value for a stock, we are faced with the problem of having to make a lot of assumptions – and therefore increasing the risk of making wrong assumptions. Hence, it always makes sense to be rather cautious. I will calculate in U.S. Dollar as BABA is also trading on an U.S. stock exchange in the United States.
In the last four quarters, Alibaba generated $30.52 billion in free cash flow, and we take that amount as basis. And let’s be rather cautious and calculate only with 6% growth from now till perpetuity. As always, we calculate with a 10% discount rate, and we take 2,673 million outstanding shares. This leads to an intrinsic value of $285.45 for Alibaba and is implying that Alibaba is trading far below its intrinsic value.
And we can also make the argument that Alibaba is still trading below previous free cash flow levels and the current free cash flow (TTM numbers) might not be representative of the business. Additionally, we can argue that Alibaba might be able to generate higher growth than “only” 6% annually for the next few years. According to analysts’ estimates , Alibaba is expected to grow its bottom line with a CAGR of 8.65%. In my opinion, these growth estimates are still too cautious, and we can expect Alibaba to grow in the double digits in the years to come.
Still Negative Sentiment
Alibaba reported good results for the previous quarter – similar to other major technology companies like Tencent – but it seems like the sentiment in China is still rather negative. During the earnings call, CEO Zhang also mentioned that macroeconomic data is indicating uncertainty down the road.
In my last article about Tencent I wrote once again about one of the major macroeconomic problems in China – the rising debt levels:
While I remain optimistic that Tencent will grow at a high pace, we should not ignore the bigger picture and the storm that seems to be brewing for the Chinese economy. In an article published in 2021 I already wrote about the Chinese debt problem, which seems to worry more and more people. When searching for “China” and “debt” we find countless articles – especially in the last few months – that seem to identify this as a major problem. Right now, household debt to GDP is 61% in China and government debt to GDP is 77% after it constantly increased in the last few years. According to a New York Times article , total debt in China is estimated to be about 280% of the country’s economic output and concerns about a hard landing arise.“
Aside from the rising debt levels, the Chinese real estate and property market is reason for concern and struggling. In 2021, Evergrande sent shockwaves around the world and now Country Garden is also struggling and losing huge amounts of cash. Additionally, the business reported that it missed payments on two of its international bonds. And like in 2007 in the United States, the real estate market can always cause huge problems due to its gigantic size – the mortgage volume and therefore the risk of potentially missed payments and value loss due to declining asset prices is gigantic.
And as it is typical for any crisis – many factors are contributing and reinforcing one another. With sentiment being rather negative and consumers being rather cautious a country might fall into deflation. While it was good that China didn’t see extremely high inflation rates in the last two years, deflation is not a good sign and could become dangerous for the Chinese economy. In July 2023, the consumer price index fell 0.3% according to the National Bureau of Statistics of China.
In an CSIS article written by Qin (Maya) Mei several arguments are made why the long-awaited spending boom in China has not yet arrived and why the recovery after the COVID-19 crisis many were waiting for did not happen so far. The combination of low consumer confidence, the per capita disposable income growth still being below COVID-19 levels and the high unemployment rates (especially among young people) are problematic and are leading customers to be rather cautious. The increasing household savings are also showing that consumers are rather cautious with their spendings and are keeping back cash for rainy days.
Conclusion
When considering the macroeconomic picture, we should not be too optimistic and expect Alibaba’s stock price to explode and climb higher quickly (as some are probably expecting right now). But over the long term I am extremely bullish about Alibaba, and I would make a similar argument for the business (and stock) as I have made for Tencent. With Alibaba still trading 70% below its previous all-time highs (and other Chinese technology stocks also trading about 60% below previous all-time highs) a lot of negativity is already priced in for these stocks.
And while Alibaba’s business might continue to struggle in the coming quarters, the downside for Alibaba should be limited as the stock is already trading for such depressed multiples and any potential stock price decline will most likely be corrected within a few months in my view.
For further details see:
Alibaba: Still Deeply Undervalued