Alibaba Will Recover Once The Government Walks The Talk

Summary

• Despite the positive news on 29 April 2022, the recovery in BABA's stock was not meaningful enough at only 6.8%.
• A sustained recovery worth $3T would require more than verbal reassurance from the Chinese government.
• Nonetheless, given its risk/reward ratio, speculative investors may still add during the dip.

Andrew Burton/Getty Images News

Investment Thesis

In Alibaba's (NYSE:BABA) universe, it seems that even the Chinese government's reassurance isn't enough to fully reverse the downward spiral of the Chinese stocks. Despite the highly positive news announced on 29 April 2022, the stock only rose 11.5% from $90.86 to $101.37, then slid downwards to $97.09 before the stock market closed and remained there post-market. Given that BABA still has quite a distance to cover before reaching its historical price of over $180s and P/E valuations of over 25x, we reckon that international investors are still not entirely convinced of the Chinese market recovery yet.

BABA Stock Movement

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We shall discuss if the future looks any different for BABA now.

Is It The End Of Regulatory Scrutiny In China?

On 29 April 2022, South China Morning Post reported that the government with end the "regulatory storm over Big Tech" while boosting the slowing Chinese economy, due to the "extended COVID-19 lockdowns." Given that the quarterly economic meeting was chaired by the Chinese President Xi Jinping himself, it would seem that many international investors were encouraged by the positive news, given that stocks such as BABA, JD.com (NASDAQ:JD), and Baidu (NASDAQ:BIDU), have rallied by over 10% post announcement. Jason Hsu, a chief investment officer of Rayliant Global Advisors Ltd, said:

The Chinese ADRs are rallying in response specifically to the statement about a positive collaborative relationship between the government and China’s platform techs. The interpretation is that we have seen the last of the regulatory crackdowns. (Bloomberg)

However, we are not sure of the potential extent of the Chinese stock market recovery, given that the supportive measures only include tax cuts and fee reductions. Nonetheless, given that a symposium involving Chinese Big Tech companies, including BABA, Tencent Holdings (OTCPK:TCEHY), Meituan (OTCPK:MPNGF), and ByteDance (BDNCE), has been scheduled sometime in early May to "assure business leaders of the new direction," we may expect a drastic turnabout assuming favorable results. Supposing that the internal reports are also accurate, Chinese regulators will no longer "demand rectifications or impose surprise fines" moving forward. Sharif Farha, a portfolio manager at Safehouse Capital, said:

The market is excited by the current headlines, but to see this rally sustained we need to move from talking the talk to walking the walk. Investors are looking for an excuse to buy China tech, so it’s up to the Chinese policy makers to give them one. (Bloomberg)

However, we are not sure how the Chinese government will actually deliver on its promises, given how beaten down the stocks have been in the past year. As a result, trust will need to be earned again. This time, it may take quite a while for the international retail/ institutional investors to be invested in the Chinese stocks, given the current uncertainties surrounding China's Zero Covid Policy and the ongoing Ukraine war.

We Don't Think Recovery Be So Easy. Look At Their Zero Covid Policy

As of 1 May 2022, Beijing had entered a semi lockdown, when dozens of COVID-19 positive cases were found in the community by the end of April 2022. As a result, the capital of China has suspended schools, shut down all restaurant dining & entertainment venues, locked down multiple residential communities with metal fences, and rolled out continuous rounds of mass testing for millions of citizens, among others. Though citizens who had negative COVID-19 test results are still allowed in public settings, for now, there are many worries that Beijing may consecutively enter a complete lockdown similar to that in Shanghai, given the rising positive cases.

Now, how is China's Zero Covid Policy linked to the general recovery of the Chinese stock market? Two years post-COVID-19 pandemic, the international community had opened up its borders to international travelers and touted their forward strategies in living with the virus in order to support the recovery of the global economies. Yet, China's government has been adamant about its Zero Covid Policy, making the return to normalcy difficult, despite its 5.5% economic growth target for 2022. Based on the fact that the government has been implementing these "standard procedures" since 2020, we suspect that mass testings/lockdowns will continually be implemented whenever there is a positive case of COVID. Prof Carl Minzner, China scholar and professor of law at Fordham Law School, said:

There are people in bureaucracy who realise the real cost this is imposing on citizens. But when politics is in command there isn’t this space for anything to rise up as reasoned discourse. Xi Jinping declared victory over the virus in 2020, and [pandemic] success has become emblematic of his own personal political success. Unless Xi himself decides to back down politically, I find it difficult to imagine how China retreats from a zero-Covid policy. (The Guardian)

Even Elon Musk, the CEO of Tesla Inc (TSLA), had known better than to criticize the Chinese government during the three weeks Shanghai Lockdown in April. It had impacted the production capacity of its Shanghai Gigafactory by at least 50K out of the projected 195K production capacity per quarter. In addition, given the ongoing lockdowns, we expect a massive impact on TSLA's EV deliveries for FQ2'22, despite the implementation of the closed-loop production system. In addition, the recent lockdowns in about 45 major cities in China have left suppliers nationwide out of sync, a situation that is expected to last for several weeks, if not months.

Elon Musk's silence now is a drastic departure from the usually outspoken CEO, who had railed against the California local government for imposing the COVID-19 'shelter-in-place' in 2020. In addition, the CEO had praised China's "economic prosperity on the 100th anniversary of the Chinese Communist Party," further highlighting the fact that Musk completely understands the deep complexity of power plays in China.

As a result, we believe that there are still many uncertainties in the Chinese stock market for so long that the central government continues to utilize a heavy-handed approach in containing the COVID-19 pandemic, since it is consistent with its approach in many other instances. Namely, the nationwide crackdown on several industries in 2020 and 2021, which resulted in the loss of $3T in the market value of China's listed companies. Regaining $3T worth of investors' trust does not happen overnight.

In the meantime, we encourage you to read our previous article on BABA, which would help you better understand its position and market opportunities:

• Alibaba: Still Being Punished By The Government - Is Recovery Ever Possible?
• Alibaba: Proven Right And Wrong
• Alibaba Stock: Russian Stocks Worth Pennies - Will Chinese Stocks Suffer The Same Fate?

So, Is BABA Stock A Buy, Sell, or Hold?

BABA Revenues and Net Income

S&P Capital IQ

Nonetheless, politics aside, BABA remains a highly successful company with robust revenues, net income, and Free Cash Flow. In the last twelve months (LTM) the company reported revenues of $131.61B and net income of $10.34B, representing YoY growth of 20.2% and a decline of -55%, respectively. The decline in its net income is mostly attributed to increases in SG&A and R&D expenses, while also reporting lower interest and investment incomes. However, it is also important to note that BABA still reported impressive Free Cash Flows of $20.84B and FCF margins of 15.8% in the last twelve months, despite the ongoing uncertainty in the Chinese stock market and the start-stop COVID-19 lockdowns in multiple cities in China.

BABA Free Cash Flow and Margin

S&P Capital IQ

BABA Projected Revenue and Net Income

S&P Capital IQ

In addition, BABA is still expected to report revenues of $135.26B and net income of $22.04B for FY2022, representing YoY growth of 22.65% and a decline of 4%, respectively. In addition, the stock is also trading very attractively at an NTM P/E of 12.58x, lower than its latest 3Y mean of 22.49x and 3Y mean of 27.82x before its busted ANT IPO. Furthermore, the stock is currently trading at $97.09 on 29 April 2022, down 58% from its 52 weeks high of $236.17. Though BABA had slightly recovered by 32.4% from its 52 weeks low of $73.28, we will still rate the stock as a good buy given the risk/return ratio, assuming a favorable result post-Chinese government symposium with the Big Tech firms. Furthermore, given that BABA is expected to report its FQ4'22 earnings on 12 May 2022, there is a high possibility that the stock may continue its rally, if the company achieves consensus estimates as well.

Therefore, we reiterate our Buy rating on BABA stock, though only for speculative investors with a high tolerance for risk.

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.