Alibaba: Stock Is A Sleeping Dragon, Business Is A Monster

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About: Alibaba Group Holding Limited (BABA)
by: Stefan Redlich
Summary

Alibaba has rebounded from its lows but is still more than 25% short of its 52-week high.

While no one knows where the bottom actually is, the long-term investment case for Alibaba remains well and truly intact.

For patient and not-jittery investors, the current sell-off presents another buying opportunity.

Alibaba (BABA) has started to recover from its recent firesale prices but is still a far cry away from its 52-week high. Ongoing uncertainty regarding the tariff situation leads to large daily ups and downs but the underlying business is stronger than ever.

Source: yahoo.com

Alibaba's stock is a sleeping dragon while Alibaba's business has long awakened and sooner or later the stock price will have to follow suit, with or without tariffs. At current prices Alibaba is a long-term buy for investors able to withstand selling the stock amid current tariff uncertainty.

What is going on at Alibaba?

Alibaba is a $424B stock but is trading on daily ups and downs of at least 3% in either direction during the final quarter of the year. It has recently reported another outstanding quarter with revenues growing by 54% Y/Y to $12.4B and an EPS of $1.40 shattering expectations by a whopping $0.33.

Source: Alibaba Investor Relations

This was the first quarter factoring in the full impact of the current tariffs and as such gives good insight into what is cooking under the hood. And before going into details the impact so far is limited with the most obvious fact being that Alibaba reduced its FY19 sales guidance between 4% and 6%.

The cloud segment clocked in another massive quarter with a 90% Y/Y revenue growth in Cloud Computing. Alibaba's core business segment "Core Commerce" meanwhile generated 56% revenue growth perfectly in line with overall growth of 54% as the very strong growth in Cloud is balanced out by "just" 20-24% growth in Digital Media and Entertainment and Innovation Initiatives and Others. The cloud segment alone, as fast as it is rising, still only accounts for 7% of quarterly sales but will quickly reach double-digit revenue share at that clip.

The stock reacted positively to this and has strongly rebounded from its recent lows but certainly remains very jittery as the tariff uncertainty continues.

Chart BABA data by YCharts

It is impossible to know at which stage logical reasoning will set in boosting the stock price but Alibaba's fundamentals are certainly not an explanation as to why the stock is where it is. Chinese stocks are trapped in a massive bear market and I continue to believe that the best way to play such high-conviction stocks is really to take advantage of market overreactions and buy top-quality, high-growth companies such as Alibaba, JD (JD), Baozun (BZUN), Huya (HUYA), iQIYI (IQ) at ever cheaper prices in increments.

Certainly, this strategy could end up in buying a falling knife but provided the long-term investment thesis and business case is intact, even the longest knife will finally hit the ground. I am not investing with the intention and belief that I am able to invest right at the bottom. I am investing in companies with long-term prospects provided the overall macroeconomic environment is supportive. In case of a Black Swan event though, none of this has any meaning in the short term and declines of 50% and more are not an exception but rather the rule.

What assures me to continue doing what I am doing is that no matter how catastrophic and devastating the crisis had been in the past, years later the economy and markets always came back stronger and while it already feels like "darkest before dawn" for some investors, I believe that we are still relatively close to the top of the cycle of investor emotions at least as far as the overall markets are concerned.

For Alibaba, a lot of potential calamities have already been priced into the stock but we are nowhere near "panic" or "capitulation" mode. For some it may look like denial, a phase I currently find myself in, believing that such relentless selling is not justified based on fundamentals, while others are already in "fear" mode.

Accelerated Growth in User Base and User Engagement

The best thing in Alibaba's recent earnings release and one thing which cannot be stressed enough is that not only is it seeing strong growth in User Base and User Engagement but in fact even an acceleration.

Source: Alibaba Q3/2018 Earnings Release

At this stage, it is not about profits for Alibaba as the company is heavily investing back into growing its business via partnerships, acquisitions and future technologies, but for metrics like user growth. And on that dimension, Alibaba clearly delivered by adding a 32 million mobile MAUs during the quarter and growing overall mobile MAUs by 21% or 117 million users over the 12-month period. Needless to say that this represents record highs for both mobile MAUs and annual active consumers. The long-term growth trend for both metrics is still very intact and shows ongoing year double-digit growth and lesser sequential increases.

This strong growth was aided by Alibaba launching a new user interface for Taobao and according to Alibaba with

"the aim to further customize the shopping experience by segmenting users based on their shopping behavior, and including more recommendation feeds to enhance product and content discovery. In turn, the new interface enhances the ability of merchants to target, engage and retain consumers. This improvement in user experience and merchant value proposition would not have been possible without our deep consumer insights and our proprietary technology backed by AI algorithms."

Source: Alibaba Q3/2018 Press Release

Source: Q3 Earnings Slides

This shows that Alibaba's massive investments into its proprietary technology advancement is paying off. They have deep insights into user preferences and behavior and can thus better engage and attract them to the platform.

The market was also not happy with Alibaba's recent Single's Day Performance but we need to take that into perspective both from a historic angle and by comparing it to competitors.

Source: Alibaba Earnings Releases

Over the last 6 years, it has roughly increased GMV 6 times clocking in consistent mid-to-high double digit growth rates. This year it grew sales by around 22% and while one can expect a deceleration in growth the bigger the company gets a decline of around 50% from its growth rate in 2017 looks alarming. At this stage, it is unclear where that tremendous slowdown originated from but based on what we know I will not read too much into these figures. It surely factors in some sort of tariff impact as the Chinese economy started to "slow down" to around 6.5% in the third quarter but could also mean that the more this event is adopted in China and world-wide the less easy it is for customers to actually buy something as they may be simply overwhelmed, if not even spammed, with offers everywhere. This would not surprise me given that 180,000 participating brands were involved and that customers from basically everywhere in the world (230 countries) completed transactions. From these figures alone I cannot sense any weakness in China's consumption's economy or the willingness of consumers to "upgrade their everyday lifestyles". Also, at Alibaba's current valuation of around 28 times earnings, it is simply neither realistic nor necessary to grow at 40%.

These results are even more impressive if we can compare them to America's biggest shopping festival from Black Friday to Cyber Monday which "only" generated around $20B in sales but for all of retail. And on a company vs. company comparison even Amazon's Prime Day 2018 sale of an estimated $3.6B is light years behind what Alibaba generated, although to be fair it was an 11-day period for this year's Singles Day but the bulk of sales were still generated on 11/11 with a whopping $1.44B within the opening minutes.

Secular growth market

Alibaba's core market - the Chinese e-commerce market - is forecast to almost double by 2022 reaching a size of $1.8T, according to a report "E-commerce in China: Trends and Outlook for the Largest e-commerce Market in the world" by research firm Forrester. To put that into perspective, this means that the Chinese online retail market will be more than double the size of the US market three years from now.

In the U.S., online retail giant Amazon (AMZN) holds a commanding market share of almost 50% and despite the recent drop, boasts a market cap of $860B, more than double Alibaba's current market cap of $420B.

Source: techcrunch.com

Alibaba itself is also dominating its core market by reigning at the top with 58% market share, with JD.com (JD) and newly IPOed Pinduoduo (PDD) a distinct second and third.

Source: statista.com

It is hard to fathom the enormous size of the Chinese online retail market. But given that China's population is more than 4 times larger than that of the U.S., with a GDP of roughly 60% of the U.S., an online market double the size of the U.S. does not seem unrealistic. If we now consider that Amazon with a slightly worse market share than Alibaba, in a market roughly half that of the Chinese market, is boasting a market cap more than twice as large, we can easily see that there is a significant valuation mismatch between these two giants.

Investor Take-Away

Alibaba is a sleeping dragon but only as far as its stock price is concerned. While the stock is trading at discounted prices, the underlying business is firing on all cylinders. Already enacted tariffs and uncertainty surrounding the entire tariff situation has certainly also hurt the business but to a much lesser degree than what the stock price reflects.

Source: Self-made graphic using images from kingstonware

In the long term, China's economy will greatly outpace and outgrow the U.S. economy and thus provides almost unlimited potential for Alibaba and its Chinese peers to grow and prosper. Alibaba is currently not even worth half as much as Amazon, yet is growing its Cloud segment at double the pace of Amazon and will own a dominating market share in a market estimated to be a twice as large as the U.S. market in three years.

Once this gets factored into the stock, it will lift off and today's prices will be viewed as what they are, namely fantastic buying opportunities for the long-term patient investor.

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Disclosure: I am/we are long BABA, AMZN, JD, BZUN, HUYA, IQ. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am not offering financial advice but only my personal opinion. Investors may take further aspects and their own due diligence into consideration before making a decision