Alibaba Stock: Time to Fish the Bottom (NYSE: BABA)

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Ali Baba (NYSE: BABA) will release its FY2Q23 quarter results in about two weeks. As the stock has trended lower since the last quarter, expectations are hitting rock bottom levels and with a low bar to beat, Alibaba is like a coil spring, ready to bounce on any good news. In fact, I think certain factors will cause the stock to reprice and shift sentiment more positively. It’s only a matter of time before that happens and, in my opinion, it’s not a matter of if, but of when. My goal is to help investors see that we may be near the bottom, rather than only realizing in hindsight that the bottom has already been reached.

Investment thesis

Alibaba is a stock I’ve been writing about for some time and previous posts can be found here. Since the last article, I think we’ve seen investor sentiment around Alibaba worsen given delisting risk and macro concerns. However, as highlighted in this article, the risk of delisting is overblown, in my view, and any lifting of the hurdles on that front will serve as a huge catalyst for the stock price. On the other hand, macro concerns around Alibaba are real given that e-commerce will slow if consumer sentiment weakens. That said, as explained below, online retail sales numbers actually improved in the quarter, which should positively surprise investors in the upcoming fiscal 2Q23 results. I like Alibaba’s risk/reward opportunity, and it remains an attractive contrarian investment for the following reasons:

  1. Chinese trade: Management is focused on driving quality growth in the commerce segment in China, as Alibaba has more than 1 billion users on its platforms who each spend around $1,300 a year. This provides an additional monetization opportunity as well as a chance to increase wallet share per user.
  2. International trade: Lazada remains one of the fastest growing and promising segments for Alibaba given that there are structural tailwinds driving international markets, such as low e-commerce penetration in Southeast Asia. As such, Lazada will be a key long-term growth driver as management uses Chinese e-commerce expertise to expand internationally.
  3. Cloud: While Alibaba has been hit by the crackdown on big tech companies in China, it continues to maintain its market leadership position in the Asia-Pacific region and gain share in China’s cloud market. Ali Cloud will be looking to expand overseas as it has several levers to move into its next phase of growth.
  4. Investing for future growth: Alibaba continues to invest for the future, especially in key strategic and technology areas that will help it build the capabilities necessary for long-term, sustainable and quality growth.

The elephant in the room

The PCAOB accounting audits to be conducted on Alibaba raise concerns. In my opinion, investors have been too negative about the PCAOB’s accounting audits. First, the ongoing PCAOB audits concern a group of Chinese companies listed in the United States. Second, it should be noted that Alibaba’s CFO reiterated that Alibaba’s financial statements are prepared in accordance with US GAAP standards and rules, audited by PwC Hong Kong, and its financial statements have received a qualified opinion from PWC every year.

As such, aside from potential further macro weakness, the other biggest overhang on Alibaba at the moment is the ongoing audits by the PCAOB, as there are concerns that the PCAOB could find issues with the financials. from Alibaba.

In fact, after the signing of the agreement between the US and Chinese authorities in August, it has significantly reduced the risks of ADR de-reimbursement which, in my opinion, has not yet been fully taken into account.

Additionally, US audit inspectors are also said to have completed their on-site work in China ahead of schedule, signaling some sort of progress in the process as well as an increased likelihood that no issues will be found.

Finally, Alibaba’s listing in Hong Kong could be approved for Southbound Stock Connect, potentially early in CY2023. This is certainly another bright spot, as more mainland investors can boost demand and liquidity for Hong Kong-listed stocks.

Improved online retail sales growth trends

Based on the 2022 YTD online retail sales growth figures below, we can see that since July there has been a recovery in YTD online retail sales growth from 2.9% in May to 4.0% in September. In fact, the most recent NBS figures for September were slightly higher than expected, as online retail sales of 6.2% yoy and physical online sales of 8.3% yoy in September suggest that online consumption continues to increase as the pandemic continues.

Improved retail sales in China

Improved retail sales in China (NBS)

The efficiencies could be a knight in shining armor

There is no doubt that the macro concerns are there. This is understandable given the uncertainty in the global macroeconomic environment. However, I think one area that might be overlooked by investors is Alibaba’s profitability angle. The focus should be on efficiencies, which I think might surprise positively given management’s priorities over the past few quarters.

I think we could see better than expected EBITDA and profitability thanks to efficiencies. This comes as Alibaba’s management continues to optimize capital expenditure on its strategic initiatives, as well as further improve operational efficiency. I think we might see less losses in some companies like Taobao Deals, Taocaiicai and Freshippo.

Evaluation

Due to a large number of different business types under Alibaba, I keep trying to value Alibaba using a sum of coin valuation model.

  1. For Chinese trade, my financial forecast for 2023F has been lowered, in my view, as I factored in a potential slowdown in Chinese trade due to a weakening macro environment in China, which could affect sentiment short-term consumers and hence, short-term e-commerce demand.
  2. For Cainiao, Local Services and other associated companies and holdings held by Alibaba, these are valued according to the latest market capitalizations and transaction values ​​of the respective companies, taking into account recent changes in the price of their respective shares.
  3. For Cloud, International Trade and Youku, I use a DCF method to determine the value of these trades based on a forecast of the future performance of each of these business segments. My forecasts include assumptions of Lazada’s long-term growth potential in the international business segment, as well as international expansion opportunities for the Cloud segment.

Applying a 30% discount, Alibaba’s target price is $143, implying a 105% upside from current levels.

Alibaba target price - coin valuation model sum

Alibaba target price – coin valuation model sum (Model generated by the author)

Risks

Competition

Alibaba remains in a vulnerable position given its size. It must continue to invest in the future, because its leading position could be severely tested if its competitors continue to innovate. In the e-commerce sector in China, local players such as JD.com (JD) and Pinduoduo (PDD) remain fierce competitors as the e-commerce landscape in China matures. In addition to these e-commerce players, there is also competition in the form of TikTok and other formats that compete with Alibaba. In its international e-commerce segment, Amazon (AMZN) and Sea Limited’s Shopee (SE) remain committed to international expansion and add further pressure to Lazada’s business segments.

Regulatory and political risks

As the tech crackdown and past joint prosperity measures have illustrated, there are still risks that China’s crackdown on big tech is not yet over. With the 20th Chinese Party Congress over, it remains to be seen how Xi Jinping’s new team could handle big tech in China. If there are any signs that the big tech and antitrust crackdowns are over, this will pose an upside risk to Alibaba, as it has been the hardest hit by regulatory and political risks. If the crackdown on big Chinese tech companies continues, it could cause more pain for Alibaba shareholders.

Cloud risks

While Alibaba has a strong position in the cloud market and has continued to gain market share from other players in China, competition from players such as Huawei, Tencent (OTCPK:TCEHY) and China Telecom could make trading in the segment more difficult as growth and margins are likely affected.

Conclusion

Alibaba is like a coil spring ready to rebound. With good news as catalysts, it’s not a matter of if, but a matter of when. As there are more and more signs that delisting risks are slowly improving, this should remove a huge overhang in Alibaba stock, as this has been one of the biggest concerns for the stock. Another concern is macroeconomic weakening, which will negatively affect e-commerce businesses. On a positive note, online retail sales data for the quarter showed better-than-expected growth in numbers, which may surprise China’s e-commerce growth for the quarter. Finally, management continues to prioritize efficiencies and cost structure improvements, which could lead to a positive surprise on EBITDA and profitability in upcoming quarterly results. Based on a sum of coin valuation, the target price for Alibaba is $143, implying a 105% upside from current levels.

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