- Alibaba's Q3 FY 2022 financial performance was mixed, after considering both lackluster revenue growth for specific segments and the increase in new users.
- Alibaba's 2025 outlook is dependent on its success in delivering ARPU growth for the company's China commerce business and diversifying its client base for its cloud business.
- The key medium-term catalysts for BABA are potential spin-offs and a more favorable regulatory environment for Chinese internet companies.
- I still keep a Hold rating for Alibaba's shares, considering its expected investment return and 2025 outlook.
- Looking for more investing ideas like this one? Get them exclusively at Asia Value & Moat Stocks. Learn More »
I retain my Hold rating for Alibaba Group Holding Limited (NYSE:BABA) [9988:HK]. In my previous article published on December 3, 2021, I noted that "I am not optimistic that BABA's shares can stage a strong rebound in the near term" and I turned out to be right thus far with Alibaba's shares down by -5.8% in the past three months.
Alibaba's Stock Price Performance Following My Earlier Update
I focus on Alibaba's intermediate-term outlook in this latest update. In 2025, Alibaba should be a company boasting slower revenue growth albeit with stable profitability. Key factors that investors should consider in assessing BABA's outlook include ARPU growth for the China commerce business and the diversification efforts for its cloud business. The more moderate top line growth expectations imply that the stock deserves a lower P/E multiple. My valuation for Alibaba suggests a +9.4% three-year investment return CAGR for its shares, which warrants a Hold investment rating for the stock.
BABA Stock Key Metrics
Before I highlight where Alibaba will be and what its shares will be worth in 2025, I do a review of BABA's Q3 FY 2022 (YE March 31) financial results focusing on specific metrics.
There are three key financial and operating metrics that were disclosed as part of Alibaba's most recent quarterly earnings which warrant more attention.
Firstly, BABA's customer management revenue for the company's core China commerce business declined by -1% YoY to RMB100.1 billion, as indicated in the company's Q3 FY 2022 earnings presentation.
I mentioned in my prior December 3, 2021 update that "Alibaba's customer management revenue growth slowed considerably from +14% YoY in Q1 FY 2022 to +3% YoY" for Q2 FY 2022. In other words, the financial performance of Alibaba's core China commerce business has gotten worse in recent quarters.
BABA explained at its Q3 FY 2022 investor briefing on February 24, 2022 that "slowing market conditions and competition in the China e-commerce market" and "increased merchant support" were responsible for the decrease in its China commerce business' customer management revenue. These were the same reasons for the moderation in Alibaba's customer revenue growth on a YoY basis in Q2 FY 2022.
The near-term outlook for Alibaba's China commerce business remains murky. Alibaba acknowledged at its recent quarterly earnings call that no one can be certain whether there will be a "V-shaped or a U-shaped recovery" for consumer demand in the country.
Secondly, Alibaba's cloud business segment only registered a "relatively modest" +20% YoY revenue growth in the third quarter of fiscal 2022. In comparison, revenue for BABA's cloud business segment grew by a much faster +33% YoY in Q2 FY 2022. This implies that the cloud segment's revenue actually decreased by -2% QoQ in the most recent quarter.
Alibaba did clarify at the company's Q3 FY 2022 results call that its cloud business' revenue growth would have been a higher +29% YoY if the effects of "a top cloud customer's decision to stop using our overseas cloud services for its international business due to non-product-related requirements" were adjusted for. This client is speculated to be ByteDance best known for its short-form video platform TikTok.
BABA also highlighted that its cloud business was affected by "slowing demand from customers in the Internet industry such as online entertainment and education." In other words, Alibaba's cloud segment was hurt by policy headwinds for specific industries in China, as the Chinese authorities have introduced new regulations to tighten their control over entertainment and tutoring businesses in recent months. It didn't help that Alibaba suffers from sector concentration risks, with slightly less than half of the clients for its cloud business operating in the internet industry as disclosed at its recent earnings call.
Thirdly, Alibaba's annual active consumers for its China commerce business expanded by +13% YoY and +2% QoQ to 882 million as indicated in its quarterly results presentation. This suggests that BABA is on track to hit the one billion annual active consumers target by the end of the fourth quarter of fiscal 2022.
I noted in my early-December 2021 article that Alibaba has put in significant efforts to "expand aggressively in the grocery product category and the lower-tier Chinese cities" and that has clearly paid off as evidenced by the growth in the company's China commerce business annual active customers in the recent quarter.
In summary, it has been a mixed quarter for Alibaba in Q3 FY 2022. The growth for BABA's customer management revenue and its cloud business top line in the most recent quarter were disappointing. On the flip side, it is encouraging that Alibaba has continued to be successful in acquiring new users in China.
What Will Alibaba Stock Be Worth In 2025?
The market consensus sees Alibaba growing its top line by a +13.5% CAGR from RMB859 billion (forecasted) in fiscal 2022 to RMB1,257 billion in FY 2025, as per the sell-side consensus estimates sourced from S&P Capital IQ. BABA's normalized net profit margin is expected to be relatively stable in the next few years staying in the 16.1%-16.7% range between FY 2022 and FY 2025.
The revenue growth expectations for Alibaba appear to be very realistic. BABA's revenue CAGR for the FY 2017-2021 period was +46%, but it is reasonable to forecast that Alibaba will witness a much more moderate pace of top line expansion going forward, considering the slowdown in the growth of its core China commerce business as highlighted in the preceding section.
On the flip side, Alibaba can still generate a low-to-mid teens revenue growth in the medium to long term by increasing the China commerce segment's Average Revenue Per User, or ARPU, and broadening its cloud segment's customer base.
At the company's recent Q3 FY 2022 earnings call, Alibaba emphasized that it will "focus on shift from new user acquisition to user retention and ARPU growth." As per the chart below, there is still lots of potential for BABA to increase the ARPU for its China consumers by expanding its presence in new product categories to grab greater wallet share.
China Commerce Business' Wallet Share
Also, as highlighted above, Alibaba's cloud business has a relatively high concentration of customers that belong to the internet industry, which has negatively impacted its Q3 FY 2022 segment performance. As such, there are good reasons for Alibaba to diversify its client base and try to win new clients in other non-internet industries. As indicated in the chart below, BABA's cloud segment is seeking opportunities to expand in the "public services", "new retail", "new finance", "transportation" and "manufacturing" in the future.
Cloud Business' Future Areas Of Focus
Separately, the assumption of flattish net profit margins for Alibaba in the next couple of years are quite reasonable. I highlighted in my December article that "stiffer competition (in the China commerce market) translates into a need for greater investments which will hurt BABA's profitability in the near term." On the other hand, Alibaba's other non-commerce businesses like cloud are growing rapidly and should see improved profitability as a result of positive operating leverage as they scale up. Net-net, stable profitability for Alibaba in the intermediate term is a reasonable assumption as I mentioned.
My valuation implies that Alibaba's shares will be worth $138 in 2025, and this implies a three-year investment CAGR of +9.4% based on the company's last traded share price of $105.42 as of March 2, 2022. The $138 price target is calculated by applying a 12 times P/E multiple to the sell-side consensus' normalized earnings per share forecast of RMB72.8 (or $11.5). The P/E multiple of 12 times appears to be low. But as I mentioned in my previous article, "a slower-growth company whose business activities are regulated tightly by the authorities" is justified "trading at a modest P/E valuation multiple."
What Catalysts Should Investors Watch For By 2025?
There are two key catalysts that investors should watch for by 2025 which could provide further upside.
The first catalyst is potential spin-offs of Alibaba's other businesses (apart from its China commerce business) like its logistics business Cainiao or international e-commerce business Lazada.
As an internet conglomerate, it is inevitable that BABA gets assigned a holding company discount by the market for owning multiple businesses where the disclosures for individual segments are limited. There are signs that Alibaba could be considering separating these businesses in the intermediate term.
Alibaba stressed at its recent Q3 FY 2022 investor briefing that "the market has not placed sufficient value on Alibaba's business in terms of how it's being driven by a multi-engine strategy", and emphasized that "the full value of each of these businesses together is not being reflected" in its share price and valuations. More importantly, BABA noted that it "will maintain an open attitude" to "bring in more diverse investor bases and help these companies grow as independent entities."
The other key catalyst for Alibaba is the easing of policy and regulatory headwinds for China internet companies.
Another Chinese internet company, Meituan (OTCPK:MPNGF) [3690:HK] was reported by Reuters on March 1, 2022 to "lower commissions for merchants on its platform" following "guidance for online food delivery platforms to reduce service fees to help to lower operating costs for catering businesses" that was issued by the Chinese authorities.
This latest event suggests that regulators in China probably still hold the view that large Chinese internet companies are "over-earning" at the expense of consumers. As such, it will probably take more time before policymakers ease the regulatory pressures for the Chinese internet sector. If and when there is a window where there are limited or no new regulations targeting internet companies in China, this could serve as a re-rating catalyst for Alibaba.
In summary, the key medium-term re-rating catalysts for Alibaba are spin-offs to narrow the holding company discount and an end to the regulatory crackdown on the Chinese internet sector.
Is BABA Stock A Buy, Sell, Or Hold?
BABA stock is still a Hold. As I detailed in my valuation for BABA in an earlier section of this article, I expect Alibaba to deliver an investment return CAGR of +9.4% in the next three years up to 2025. This only supports a Hold investment rating in my opinion; I expect at least a mid-teens investment return CAGR to justify a Buy call.
Asia Value & Moat Stocks is a research service for value investors seeking Asia-listed stocks with a huge gap between price and intrinsic value, leaning towards deep value balance sheet bargains (i.e. buying assets at a discount e.g. net cash stocks, net-nets, low P/B stocks, sum-of-the-parts discounts) and wide moat stocks (i.e. buying earnings power at a discount in great companies like "Magic Formula" stocks, high-quality businesses, hidden champions and wide moat compounders). Sign up here to get started today!
This article was written by
Those who believe that the pendulum will move in one direction forever or reside at an extreme forever eventually will lose huge sums. Those who understand the pendulum's behavior can benefit enormously. ~ Howard Marks
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. 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.