Alibaba Is A Strong Buy Before Earnings
Summary
- Alibaba faces a fresh catalyst next week when earnings are expected to be released.
- Earnings for the last quarter will likely see strong momentum in e-commerce sales.
- A strong e-commerce performance could result in rising revenue estimates for next year.
- Alibaba could become a $52B free cash flow business by FY 2026.
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Alibaba (NYSE:BABA) is expected to open up its books for the September quarter this week. The internet giant will likely see strong performance in its core commercial segment and improving free cash flow. Shares of Alibaba are poised to deliver strong returns in the future!
Why Alibaba is a buy before earnings
Shares of Alibaba have been in for a roller-coaster ride this year. Alibaba was caught in the middle of a major crackdown on multiple sectors of the Chinese economy in 2021. After the CCP decided to strengthen regulatory oversight and force Chinese enterprises to consider China's national security interests as part of their business strategies, valuations for major Chinese growth stocks cratered. The crackdown started off with financial service providers which made cryptocurrencies available to their customers and quickly spread to e-commerce companies, internet firms offering gaming products for children, for-profit businesses and even food delivery startups. The justification for Beijing in all of these instances has been to uphold rules of economic fairness by cracking down on companies that are said to engage in monopolistic behavior. Most large Chinese companies were targeted by China's anti-trust watchdog, the State Administration for Market Regulation, including Alibaba and Tencent (OTCPK:TCEHY).
Most recently, enforcement regulations have taken a backseat to a new force emerging in the Chinese stock market: Multiple Chinese real estate and development firms are nearing bankruptcy as a downturn in property prices created a liquidity crisis that might get worse. Relying on massive amounts of easy debt, these firms have built development projects on speculation. Now that prices are dropping, the supply-demand mismatch is creating serious liquidity problems for firms like Modern Land, China Properties Group or Evergrande (OTC:EGRNF).
Alibaba may be able to escape the selling pressure in the Chinese market if the company tables an impressive earnings card for the last quarter next week and I believe Alibaba will be able to do this! Although there is no official earnings date announcement, the earnings card is expected for November 4, 2021, according to Nasdaq information.
Alibaba's e-commerce business is soaring, and the segment's growth even accelerated during the global Coronavirus pandemic. Alibaba's e-commerce business, responsible for 88% of revenues and 92% of EBITDA profits, is far and away the most important business driver for Alibaba. An additional breakdown of Alibaba's e-commerce revenues shows that international e-commerce retail and Alibaba's logistics business, branded under the name Cainiao, saw the highest year-over-year growth rates of 54% and 50%. The Cainiao network is expanding rapidly in China but also invests in a smart logistics network to deal with accelerating cross-border transactions.
(Source: Alibaba)
Alibaba is also looking forward to generating higher free cash flow in the future, which could drive a revaluation of Alibaba's shares. This is because the company's free cash flow in the last quarter was impacted by China's anti-monopoly fine which lowered the firm's free cash flow by 9.1B Chinese Yuan ($1.4B). The total fine was 18.2B Chinese Yuan ($2.8B) and was levied on Alibaba due to alleged anti-competitive practices. Although Alibaba recognized 50% of the anti-trust fine, the free cash flow was still 20.8B Chinese Yuan ($3.3B). Alibaba's free cash flow margin, after accounting for the anti-trust fine, was 10%. In the year-earlier period, Alibaba's free cash flow margin was 24%. I believe Alibaba could return to a 20% free cash flow margin next year.
(Source: Alibaba)
Looking ahead into the future, we can see that Alibaba's revenues are modeled to grow at a rate of 17% annually between FY 2021 and FY 2026. After receiving a big fine this year, Alibaba played nice with the CCP which could reduce the probability of receiving new fines in the future.
Let's assume that Alibaba will not get any more anti-monopoly fines and grow revenues at a rate of 17% annually, which is implied in revenue forecasts until FY 2026.
(Source: Seeking Alpha)
By 2026, Alibaba is expected to have revenues of $263.7B. If Alibaba's free cash flow margin stabilizes around 20% over the next five-year period, which I believe is plausible, then it could become a $52B a year free cash flow business… and the estimates have upside because Alibaba's other two businesses, digital media and cloud computing, will also start to make positive cash contributions to the firm. After all is said and done, I believe Alibaba could generate $52B in annual free cash flow by FY 2026, which is twice the free cash flow the firm generates currently. The firm's free cash flow is cheap compared to last year.
Revenue estimates are rising and should continue to rise after results for the September quarter have been submitted. Alibaba's P-S ratio is just 2.4, less than half the ratio from last year!
Risks with Alibaba
There are a couple of risks that have the potential to overshadow Alibaba's commercial performance, especially as it relates to e-commerce. The biggest risk, as I see it, is a large-scale default of one of China's largest property developers, like Evergrande. Evergrande is saddled with $305B in debt and teetering on the brink of collapse, and other developers are also on shaky ground and might default at any moment. A default of Evergrande would likely have serious implications for stock markets worldwide and could pull Alibaba lower even if the e-commerce giant generates strong revenue and cash flow. Additionally, I believe new anti-trust fines, as unlikely as they are, could impact Alibaba's valuation.
Final thoughts
Alibaba is likely going to present a strong earnings card for the last quarter, mostly because e-commerce is surging and Alibaba is the largest and most important e-commerce platform in China. Alibaba's risks are chiefly macro-style and the firm's free cash flow is set to improve significantly in the future. Due to Alibaba's attractive valuation based off of sales and free cash flow, BABA shares have a great future!
This article was written by
Analyst’s Disclosure: I/we have a beneficial long position in the shares of BABA, BIDU 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.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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