Ongoing tensions between the U.S. and China and unreliable back-and-forth in communication paired with the exit of a large shareholder have triggered a correction in Alibaba's (BABA) stock price.
Source: Alibaba Investor Relations
Despite stellar earnings and financials, investors take a much more negative view currently as sentiment is vastly dominated by reacting to the latest developments in the trade war dispute. By overestimating the impact of the trade war and underestimating Alibaba's long-term growth trajectory, the stock has been taken to the cleaners and presents an excellent long-term opportunity for conviction bulls.
What is going on at Alibaba?
Alibaba's latest earnings are just the logical consequence of its long-term growth path. Organic revenue growth amounted to 39% Y/Y with EPS coming in at $1.28, both metrics easily beating consensus.
Going forward, for investors focusing on fundamentals and facts rather than rumors and fear, the following themes are crucial:
- The Trade War is currently no substantial threat to Alibaba
- Altaba is exiting shares creating temporary headwinds
- Think long-term with Alibaba
Let's explore these one-by-one.
The Trade War is currently no substantial threat to Alibaba
I believe markets have been overlooking the very assuring commentary by Joseph Tsai, Executive Vice Chairman of Alibaba, during the most recent earnings call covering the topic of the trade war and how it impacts Alibaba.
The quintessence of it all boils down to this statement:
In short, the trade talks put Alibaba on the right side of all the issues on the table
Source: Alibaba FY2019 Q4 Earnings Call
That's a bold statement to make but it is backed up by several examples.
First, the main reason for the trade war is the big trade deficit of the U.S. with China as the latter exports more than it imports. However, given the secular trend in China which encompasses the rise of the middle-class and the transition from a manufacturing hub for the world towards a service market and digitized economy, this will naturally lead to Chinese importing more over time, with or without any sort of trade agreement.
Consumers in China will benefit from the availability of quality imported products from all over the world, including from American farmers, brands, and small businesses. Alibaba is set up to benefit from this secular trend of growing imports into China. We are the platform of choice for global producers, products, and brands selling into China because we have the reach and deep insights on over 650 million active Chinese consumers on our platform.
There is simply no other company in China with a similar reach and customer base (over 650 million active consumers) and thus the ability to benefit from this unstoppable development.
Tariffs alone, unless they reach spectacular dimensions, won't be enough to derail Chinese growth as the rising middle class has already reached "critical mass of over 300 million," or roughly the size of the entire U.S. population. Rising income and expansion of that massive middle class will provide strong impetus to China's economic growth as it drives domestic consumption and Alibaba will be perfectly positioned to benefit from that growth in third-, fourth-, and fifth-tier cities.
Finally, on intellectual property Tsai commented that:
In recent years, China has made significant improvements in reducing IP infringement, as China moves closer to global norms in protecting and paying for foreign IP
Source: Alibaba FY2019 Q4 Earnings Call
That is true but such a statement is all relative and it is tough to measure how well a country protects international IP rights. China has been notorious for counterfeits and copy-cat products for years and decades and forced technology transfer for companies that want to do business in China is a well-known issue. It is absolutely crucial that this gets addressed but on that aspect, I am less optimistic than Mr. Tsai in terms of how fast and easily those "vexing issues in the trade negotiations will resolve themselves."
Still, overall the message is very clear that rising domestic consumption and the expansion of the middle class will both boost China's economy as well as lead to rising imports from the U.S., the only question is what type of imports the U.S. economy can offer to the Chinese. Alibaba is mostly referring to "American farmers, brands, and small businesses" rather than to high-tech products in strategically important sectors such as information technology, automobile, aerospace and industrials as China intends to develop and form its own, likely state-owned, companies in these sectors.
I fully believe that the trade war will be resolved but I don't think it will be as straightforward and natural as Mr. Tsai is picturing the world. In any case though, Alibaba will benefit from these developments as its customer base has grown so large that it has already become synonymous with everyday consumption in China.
Altaba is exiting shares creating temporary headwinds
Creating further headwinds to the stock is the fact that Altaba (AABA) which owns 11% of Alibaba has approved its liquidation and dissolution which implies that it will dispose all its remaining 11% Alibaba stake.
Jefferies notes that this is "just a near-term overhang on Alibaba stock" since "Alibaba's fundamentals are still intact amid expansion into China's online consumption pockets."
This liquidation plan has started on May 20 and is expected to end by the fourth quarter thus triggering more sales of Alibaba stock and pushing the price down. These temporary headwinds are actually great news to long-term investors as they lower the valuation of the stock without impacting Alibaba's fundamentals whatsoever and thereby creating a promising long-term buying opportunity.
Think long term with Alibaba
And long term is what really counts for Alibaba. Management itself shared a very interesting perspective in the context of the Chinese economy:
The size of the Chinese economy is US$13 Trillion. In the future, obsessing on the rate of growth is not meaningful, because of the law of large numbers. The reality is the absolute dollar amount of new wealth creation in the Chinese economy will be well over US$800 billion each year.
We have conviction that e-commerce and digitization of retail will continue to grow at a faster rate than the overall economy. While the overall economy grew in single digits, e-commerce sector GMV grew at 20% to 30% over the last several years.
In my view, the Chinese e-commerce market is the best secular growth market for a company to be operating in. Alibaba itself thinks that the law of large numbers paired with high growth rates needs no further arguments for long-term investors.
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.
The two mega trends fueling this development is the ongoing transformation of China's economy from manufacturing to services and the accompanying growth in disposable income as well as a stronger and growing domestic consumption economy.
That’s a big macro trend that’ll last for many years, as well as in the future, China importing a lot more. With a government commitment as well as reaction to the trade negotiations, China will make commitments to import more. So, these are all the macro factors that we actually factor into our business, and in fact, if you’re looking at our business as swimming in a stream, if you will, or swimming – flowing in the direction of the tide as opposed to going upstream against the tide, because all those long-term secular macro factors are actually providing the tailwind to push our business forward.
Source: Alibaba FY2019 Q4 Earnings Call
Alibaba is China's industry leader in the world's largest and one of the fastest-growing e-commerce markets. The trade war may temporarily slow down Alibaba's momentum but so far, all signs point towards ongoing strong double-digit growth. The rise of the middle-class and resulting surge in domestic consumption will further propel Alibaba's sales and thus the current pullback in the stock is a great long-term buying opportunity. Once the trade war is resolved, Alibaba stands to be one of the main beneficiaries and should see its punished stock price rapidly getting lifted.
Hardly a week passes without any noteworthy news surrounding Alibaba. Apart from the trade war, the most recent news surround Alibaba's smart speaker hitting the road, a 49.9% stake in a Russian joint venture, a $100M investment in Indian TikTok competitor Vmate as well as Alibaba's plans for a $20B Hong Kong listing.
The business is firing on all cylinders and with the long-term growth trajectory fully intact it is a generational buy, especially at current prices.
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Disclosure: I am/we are long BABA. 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.