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Thursday, June 3, 2021

Alibaba: One of the Cheap Bargains in This Market

I have been looking around in the stock market and haven't found many stocks that are undervalued. Currently, in a market full of elevated asset prices, it can be difficult for investors to find underappreciated securities on a valuation basis. I have seen stocks like Game Stop Inc. (Ticker: GME) gone up in price without seeing any fundamental value for its price appreciation. 

I have been following Alibaba Group (Ticker: BABA) for quite some time already. I have a friend who invested all of his capital in this stock when the price was $290-$300. I placed BABA in my watch list and got my attention when the cost of the stock goes down to $210-$220 level. I believe Alibaba (Ticker: BABA) is being underappreciated through the lens of both valuation and growth potential. While investors may fear regulatory risks, management stability, and financial legitimacy, BABA's growth runway coupled with discounted prices could potentially produce a valuable investment opportunity.

 

This is the reason why I sold all my other stocks in my portfolio and invested 63% of my capital in Alibaba stock. I have written an article as to why I invested a lot of my money in this stock. Because I invested a lot of my money in Alibaba Group, I decided to research this company. I want to make sure what I did was a wise investment move. In this article, I will focus more on information about Alibaba Group (Ticker: BABA) and why I think the current price Alibaba is at is great for investors to enter. 


Business Description

Alibaba Group was founded in 1999 by 18 individuals. Nevertheless, one of these 18 stands out – the former English teacher from Hangzhou, Jack Ma. Over the years, Alibaba evolved into a multinational technology company, and with a market capitalization of $570 billion, Alibaba is on the 10th spot on the list of most valuable companies globally (by market cap). And behind Tencent, which is on the 7th spot on that list, Alibaba is the second most valuable company in China.

 

While Alibaba is mainly focused on e-commerce and retail operations, the Alibaba Group is a holding company with many different sales services. This includes C2C services, B2C services, and B2B services. Aside from retail, the Alibaba Group also offers electronic payment services, shipping search engines, and computing services. The group owns and operates a diverse portfolio of companies around the world in numerous business sectors.



Why I Think is Cheap.

After Chinese regulators suspended the highly anticipated IPO of Ant Group due to issues surrounding changes in the financial regulatory environment and how the company was not meeting disclosure requirements, BABA's share price began seeing initial selling pressure. BABA saw an -8.13% dip in share price after the IPO was delayed. Given that BABA has a 33% equity interest in the company, the canceled listing of Ant Group caused obvious headwinds. 

 

Shortly after the canceled IPO, Jack Ma publicly denounced China's financial regulators on stage at a conference in Shanghai. Adding to the mountain of negative headlines, the outspoken founder went missing shortly after this stint, followed by a further decline in share price. Weeks after Ma's criticisms regarding China's regulators, the CCP came crashing down hard on Alibaba with an antitrust investigation based on monopolistic concerns. BABA's share price began to see deep selling pressure in late December, with the U.S.-listed ADR falling over -13% on Christmas Eve. 



After a slew of negative press, financial and regulatory headwinds, BABA has fallen ~-30% from ATH, where it currently sits just over $210 a share. With share price declining and earnings continuing to grow rapidly, Alibaba has seen valuation multiples contract to levels not seen since shortly after their NYSE listing in 2015.


Strong Business Among Strong Competitors
What is striking when looking at Alibaba – and what has been discussed several times – is the low multiple for which Alibaba is currently trading. When using the trailing twelve-month GAAP numbers, Alibaba is trading for 25 times earnings; when using the non-GAAP forward numbers, it trades for a P/E ratio of 20.

We can compare Alibaba to its peers – companies like Amazon (AMZN), Tencent, Facebook (FB), Microsoft (MSFT), or Alphabet (GOOG). And Alibaba belongs to that list as it is not only operating in similar business segments, but it is also growing with similarly high rates. And Alibaba is not only growing at a similar pace; it is outperforming most of its peers.



While Alibaba is growing at a similar pace to these companies, it is trading for an entirely different multiple. Right now, Alibaba is trading for a price-cash-flow ratio of 17, while competitors like Tencent, Facebook, or Microsoft are trading for a P/FCF ratio between 35 and 40. It is striking that the market is assigning these competitors a multiple twice as high, and Amazon is trading for a multiple more than four times higher (price-free-cash-flow ratio of 76).



Readers might point out that the comparison to Amazon is misleading as Amazon is still spending much money to achieve future growth and therefore has a lower profit than other companies. And it certainly is true that Amazon is still focusing on top-line growth – sometimes at the expense of bottom-line growth – but so does Alibaba.

 

While Amazon spent 10.4% of its revenue as capital expenditures in the last fiscal year, Alibaba spent almost the same amount – 8.9% of revenue. And when looking at the expenses for research and development, we once again see similar numbers. In the last five years, Amazon spent 12.16% of revenue on R&D on average, while Alibaba spent 10.38% of its revenue on R&D.

 

But while these numbers are pretty similar for both companies – Amazon is spending a bit more on R&D than Alibaba – the free cash flow these two companies can generate is entirely different. While Amazon only generated 6.7% of revenue as free cash flow in the last fiscal year, Alibaba generated 26.5% of revenue as free cash flow in the previous fiscal year – almost four times higher.

 

And Alibaba is not only highly profitable, but it was also growing at an extremely high pace in the past. During the past ten years, Alibaba could not only increase revenue every single year, but it also increased revenue with a CAGR of 62.6%. Earnings per share fluctuated slightly during these ten years but grew at an even higher pace – a CAGR of 76.29% during the last decade. And finally, free cash flow increased with a CAGR of 59.62% during the previous decade.



When looking at Alibaba's growth rates in the last few years compared to its competitors, Alibaba is also outperforming. When looking at the revenue CAGR of the last five years, we get the following numbers:

  • Amazon: 29.26%
  • Facebook: 36.82%
  • Tencent: 36.20%
  • Alphabet: 19.47%
  • Microsoft: 8.85%
  • Alibaba: 46.24%

We can spin it how we want: Alibaba is a highly profitable company growing with highly high rates but is trading at an extremely low multiple compared to its competitors. It is increasing at a higher pace than Microsoft and Facebook but trading for half the multiple. It is much more profitable than Amazon and growing at a higher rate, but trading for a quarter of the valuation multiple. At this point, the profitability and growth of Alibaba on the one side and the valuation multiple on the other side do not add up. And we have to ask the question, why Alibaba is trading for such a low multiple although it is outperforming many of its peers that trade for much higher multiples.

 

Growth Potential

To capture excellent investment gains, valuation is not enough; Alibaba will have to continue executing its growth strategy. While the stock seems to be cheap on a relative basis, I also believe growth on the top, and bottom lines are imminent.


After their Q1 release, BABA reported 41% YoY growth on the top-line driven by their leading core commerce segment alongside the fast-growing cloud segment. Coming off 35% YoY growth in 2020, delivering a 41% top-line increase is incredible for the year following. Given that COVID-19-related online change was reflected in early 2020 results, I find it very feasible for core commerce tailwinds to continue as growth persisted and expanded the following year.

 

Alongside general e-commerce tailwinds, China's middle-class growth could support sales for a mega-cap commerce player like Alibaba. "China already makes up the largest middle-class consumption market segment in the world" as Chinese middle-class consumers were on track to spend over $7.3 Trillion in 2020, roughly 55% higher than the United States middle-class at $4.7 Trillion. At current levels, less than one-third of China's total population lies within their middle-class, containing roughly 400 million people. Population expectations for the Chinese middle-class are expected to be 1.2 Billion people in 2027, a 17% CAGR. Coupling the sheer class population growth with a forecasted income CAGR of 3% stacked on top, BABA is potentially looking at a 20% built-in core commerce CAGR over the next seven years based on these estimates.

 

Lastly, I believe the digital transformation acceleration happening around the globe will be an excellent growth catalyst for the company moving forward. Like Amazon (NASDAQ: AMZN), Alibaba constructed its cloud base on logistical support for the commerce/delivery giant. Now that the infrastructure is built, they can grow the cloud as an operating segment, separate from core commerce, and outsource to significant customers.

 

Below you can see previous YoY growth on three months ended and annual basis.


While Alibaba Cloud only makes up 8% of total revenues, in the future, I believe this segment will be a more significant contributor to the whole top line as domestic and international adoption grows. Couple the cloud with core commerce expansion propelled forward by a rapidly increasing middle-class and BABA's growth runway is seemingly attractive for short- and long-term investors.




Are We at the Bottom?

The answer to this is I don't know. I can't time the market since I invest in stock as a value investor due to its fundamentals. When the stock price goes up, people come up with all kinds of reasons why it went up. When the stock price goes down, people come up with all sorts of reasons why it went down. The point here is that in the stock market, the price often creates the narrative; thus, it's our job as investors to figure out whether or not the narrative makes sense. Based on Alibaba's share price today, I believe the narrative does not, and more importantly, we can access value cheap. This is the main reason why I have a high conviction in investing most of my money in this stock at the current price.

2 comments:

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