Alibaba Sends A Strong Confidence Signal

Summary

• Alibaba has been a weak performer in recent months, mainly due to macro fears about Chinese regulation. These fears might be overblown.
• BABA continues to execute well, its business keeps growing rapidly.
• BABA has finally bolstered up its buyback program. This will, I believe, be highly accretive, and it is a sign of confidence from management.
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Article Thesis

Alibaba (NYSE:BABA) has seen its shares experience a lot of volatility in recent weeks, on the back of political tensions and worries about regulation in its home market. The company's most recent quarterly results were pretty solid, as they indicate that the growth story remains intact. More importantly, I believe, is management's decision to boost its buybacks. This is a sign of confidence when it comes to the company's future and a sign that those that know the company very well see it as undervalued. BABA is not a risk-free stock at all, but at the current, very low valuation, I remain bullish on this high-growth tech player.

Volatility That Isn't BABA's Fault

Looking at Alibaba's share price over the last year, we see wide swings compared to how many other tech stocks with a similar market capitalization are trading. On top of that, shares are down quite a lot from the 52-week high that was hit in October 2020, prior to the failed Ant Group IPO. Since then, shares have been on a downward path, and price swings accelerated in the very recent past, driven by news about potential crackdowns by Chinese regulators.

Online learning companies such as TAL Education (TAL) experienced the widest losses, but even companies such as Alibaba or Tencent (OTCPK:TCEHY) that are not active in this space saw their shares drop, possibly due to the fact that some investors sold Chinese companies indiscriminately.

In some cases, when one sees volatile share prices, the issues are self-made. Due to weak results, or management comments about the future, and so on. Facebook (FB), for example, saw its shares drop following its recent earnings release, despite strong quarterly results, with the likely explanation for the share price decline being that management gave conservative forward guidance. In BABA's case, the volatility and recent pressure on its shares are more driven by overall China fears that are not under the company's control - its share price decline goes hand in hand with that of many other major Chinese companies, such as JD.com (JD), Tencent, or Baidu (BIDU). These macro fears are, to some extent, justified, as there indeed is a risk of increased regulation. I doubt, however, that it is in China's best interest to hurt its innovative high-growth tech players too much, and I believe that current valuations do more than account for the risks in BABA's home market.

BABA Continues To Execute Well

On an operational basis, many things are going well for Alibaba. The company just reported its first-quarter earnings results, which featured strong numbers across many different metrics. The company did, for example, manage to grow its user count meaningfully again, showcasing that the market is far from saturated, as the user count on its platforms has been growing like clockwork. During the quarter, BABA added 14 million new users, for an annualized growth pace of a little more than 6%.

User count growth is not the only way for BABA to generate business growth for its core commerce segment, however, as there are two more important levers. The Chinese middle class is growing fast, and disposable income in the nation keeps growing. This means that, overall, Chinese consumers have more money they can spend every year, which naturally benefits consumption in the country. If market shares held constant, BABA would thus be able to grow its revenue per user regularly, in line with overall consumption growth in its home market. Due to digitalization and sales being shifted to e-commerce platforms from brick-and-mortar stores, the growth outlook for companies such as BABA is even better. Alibaba was thus able to turn its solid user growth rate into a highly attractive commerce sales growth rate of 35%, compared to the previous year's quarter. Overall revenue growth, which includes additional businesses such as its cloud computing platform and digital media, was almost in line with that, as company-wide revenues rose 34% year over year to RMB206 billion, which equates to roughly $31 billion.

Looking outside of China, BABA's growth has been even more attractive. The company's user count, on a global basis, rose by 4% sequentially, which equates to a high-teens annual growth pace. Platforms such as Philippines-focused and Singapore-based Lazada grow quickly, as Lazada has been able to generate order growth of 90% compared to the previous year's quarter. Lazada, for now, does not yet make up for a very large portion of BABA's revenues, but at this growth pace, the business will become a more important growth driver quickly.

The success of Lazada also does, I believe, prove the strength of the business model. Huge cash flows that are generated in BABA's home market can be reinvested into acquisitions and the build-out of e-commerce platforms in other Asian markets that are still underpenetrated, which in turn will allow for ample future growth.

Cloud Computing revenue growth was a bit disappointing, at 29% year over year, which was blamed on the loss of a major unnamed customer. It remains to be seen whether this was a one-time issue or whether cloud computing growth will remain at this somewhat lower level going forward. Even if ~30% growth is the new normal, however, the cloud computing business could still hold a lot of value for BABA. BABA's cloud business is roughly one-fifth the size of AWS, with a similar growth rate - considering that AWS is believed to be worth as much as $1.2 trillion in the next three years, BABA's cloud business, at one-fifth the size, could have a value of $200+ billion.

One negative in the earnings report was the relatively weak profitability, on a comparable basis, relative to the previous year. This was not a surprise, as analysts had already expected a profit decline, and in fact, profits beat estimates. Nevertheless, EBITDA was down 5% year over year, which is naturally not a great thing to see from a high-growth company like BABA. Management states that profitability headwinds were the result of increased investments to drive future user growth and revenue, one of the examples showcased was Ele.me, a food-ordering platform that has experienced 50%+ order growth during the quarter thanks to increased investments in user acquisition and quality improvement initiatives. For a growth company, it can pay off to focus on user value creation and growth instead of maxing out profitability at all costs, showcased by the immense success of Amazon (AMZN), which has, for a long time, focused on growth instead of profitability, which has allowed the company to turn into one of the largest companies on earth. It remains to be seen whether BABA can replicate that, but I personally would not read too much into the small earnings decline in Q1.

Overall, BABA remained quite profitable, as EBITDA still stood at more than $7 billion, or around $30 billion on an annual basis. Net profits were pretty strong, at $6.5 billion for the quarter, which was actually up 10% year over year. This was possible thanks to higher other income and higher contributions from equity investments, including Ant Group, which contributed ~50% more to BABA's bottom line compared to the previous year's quarter.

A Sign Of Confidence

One of the issues that I and some other investors have had with BABA in the past was the lack of shareholder returns. The company has been generating strong cash flows for years, has a healthy balance sheet, and its shares have looked inexpensive for quite some time. And yet, management was pretty reluctant to buy back its own shares, which was a bit confusing. Other major tech companies, such as Apple (AAPL) have had great success with a shareholder-focused capital allocation strategy, so it seemed surprising that BABA did not follow in the same path.

Together with its earnings results for Q1, however, BABA finally upped its share repurchase authorization, which now allows for the repurchasing of $15 billion worth of the company's stock. At current prices, that equates to roughly 3% of the company's share count. BABA has, it seems, already started to ramp up its buyback activity under the old $10 billion buyback program, as Alibaba has spent $3.7 billion on buybacks between April 1 and August 1. On an annual basis, this equates to around $11 billion, and thanks to the new program share repurchases could easily be higher going forward.

Data by YCharts

As we can see in the above chart, BABA currently trades significantly below where shares traded over the last couple of months. If management found it worthwhile to spend billions on buybacks at $200-240, they will likely be even happier to reduce the share count while shares are trading at $190 - and shareholders should think the same. Everyone that agrees that BABA is a quality growth company that trades below fair value should be happy that management is finally stepping up its buyback activity, as this should, I believe, be highly accretive for shareholder value in the long run.

The increase in the buyback program can also be seen as a sign of confidence by insiders - they seemingly agree that shares trade below fair value right here, which justifies putting more cash to use to reduce the share count. Management would likely not do this if they feared the end of the company or massive regulatory pressure down the road, as they would likely shore up more cash on the balance sheet if that was a major concern.

Is BABA A Good Stock To Own?

Alibaba is highly dependent on China, both when it comes to politics, as well as when it comes to consumer spending. That naturally goes hand in hand with some risks that should not be neglected. I do not believe that long-term risks for BABA's business model are immeasurably high, however, and I do believe that the current valuation more than accounts for the regularity risk.

BABA trades at less than 20x this year's net profits, and this is based on analyst estimates that do not yet incorporate the Q1 earnings beat. Even on that basis, shares look very cheap, especially when one considers that BABA is a leading player in a high-growth market that continues to grow its revenue by 30%+ a year. At roughly one-third of the earnings multiple of Amazon, BABA looks like the more favorable pick right here to me. BABA's decision to finally ramp up its buybacks should be another positive for investors in the long run.

BABA's shares are not cheap due to any company-specific issues, but rather due to what I believe are overblown fears about Chinese regulation. As long as one keeps allocations at a reasonable level that fits one's risk profile, having exposure to the consumer story in China and other Asian markets through BABA looks like a good idea to me.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of BABA, TCEHY, AMZN either through stock ownership, options, or other derivatives. 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.