Is Alibaba Stock A Buy Before Upcoming Earnings?

May 25, 2022 11:21 AM ETAlibaba Group Holding Limited (BABA), BABAF21 Comments

Summary

Alibaba is set to report quarterly results tomorrow (26th May 2022) before the market opens, in what is likely to be a pivotal report for the company and its shareholders.
While Alibaba has lost ~31% of its market cap year-to-date with China's economic growth in the doldrums, it is easy to argue that BABA is too cheap right now.
Alibaba is trading at ~9x P/FCF, which is very attractive despite the political and regulatory risks attached to this investment. So, should you buy before the earnings report?
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Jack Ma Awards Rural Schoolmasters In Western China — Wang He/Getty Images News

Introduction

Alibaba Group Holding Limited (NYSE:BABA) is set to release its quarterly earnings on Thursday, May 26, 2022, in pre-market hours. With the company providing no guidance for this quarter, Alibaba's investors (including founder Jack Ma) are surely concerned about how the company is performing. After all, the stock is down ~31% year-to-date and ~75% from all-time highs recorded in October 2020. While Alibaba's fall from glory has commonly been attributed to the government's regulatory actions on the technology sector in China (potentially hampering Alibaba's future growth), China's economic growth is slowing down drastically, and the government is seemingly ready to stop the attack on China's technology sector. So, is it a good time to buy Alibaba?

In the past, I have laid out a bullish thesis for Alibaba due to the long-term risk/reward on offer. And I do own a very small position in this company at a cost-basis of ~$140 per share (bought in November 2021). If you are interested in reviewing my detailed research on the company, please feel free to take a look at these notes:

Alibaba: An Opportunity Of A Lifetime Or A Tragic Mistake? [My first research note on Alibaba, triggered by lucrative relative valuation after a 50% drop in price]
Alibaba Stock: Jack 'Not Dead' Bounce! Will It Last? [A sound case for a long-term investment in BABA (based on fundamentals)]
Alibaba: Weak Quarterly Results, But Accelerated Buyback Is Bullish [I gave in to long-term business fundamentals and bought in at 15x P/FCF]

I haven't written about Alibaba since November, as the vicious drop in growth (and tech) stocks has created so many spectacular buying opportunities, and I have been spending most of my time researching these companies to identify the best long-term investments for my followers. While I plan to continue to look for more opportunities in the high-growth tech arena, I have been reading more and more articles that suggest a relaxation of regulatory attacks on Chinese tech companies, which has been the central bear thesis for Alibaba and other mega-cap tech stocks in China. Finally, this Seeking Alpha report of significant inflows into China tech ETF (KWEB) convinced me to do an update on Alibaba ahead of (what I think is) a pivotal earnings report.

Heading into tomorrow's report, Alibaba is trading at a depressed P/FCF multiple of 8.55x, indicating ultra-low expectations from the company. With China's economic growth deteriorating due to its insanely draconian 'Covid-zero' policies (forced economic shutdowns in several cities), Alibaba's numbers are likely to remain under pressure. But is Alibaba's current valuation too cheap to ignore?

Let's find out.

What To Expect From Alibaba's Earnings

To be honest, I don't know. The company's management did not provide any guidance at the end of last quarter, and we are flying blind into this earnings report. With massive economic uncertainty in China (and globally), I am not sure what Alibaba will report tomorrow, and I am eagerly waiting to see the results (as many of you reading this note are too). Here's where the consensus analyst estimates stand today:

According to these estimates, Alibaba is likely to report sales of ~$30B (y/y growth of 3.24%), which would mark a further slowdown in Alibaba's business. Considering the stagflationary environment in China, we could see another miss from Alibaba. If the recent earnings (and subsequent market reaction) from US retail/e-commerce giants like Amazon (AMZN), Walmart (WMT), and Target (TGT) are anything to go by - Alibaba's report could be perceived as terrible even if it manages to register sales growth in the mid-single digits. Hence, I am not eager to buy before the earnings report.

However, as a long-term investor, I view quarterly results as mere data points that can be used to check on the progress of a business. The quarterly results won't necessarily alter the business, and so, I think taking a big picture view here is imperative. Before we reach any conclusions, let's analyze some key metrics for Alibaba.

BABA Stock Key Metrics

After the pull forward in demand due to the Covid-19 pandemic, the days of rapid growth at Alibaba are over (at least for the foreseeable future). The company has entered a mature growth phase, which means drastically slower growth rates than what we have seen from Alibaba over the years. While Alibaba's valuation reset to match this lower growth trajectory makes sense, it may be overdone. Alibaba's core e-commerce business is still growing (off of a massive base), and its non-core businesses (growth engines) like Alibaba Cloud are still early-stage. Hence, I think that Alibaba can deliver robust compounded growth on both revenue and free cash flow.

The long-term business fundamentals for Alibaba are looking healthy, and the company will do well, barring excessive government interference (my biggest fear remains state ownership). While Alibaba's stock has tanked in the last 18 months or so (along with the other big tech names from the Chinese technology sector), the consensus rating among Wall Street analysts and SA Authors remains bullish (as can be seen below). However, Seeking Alpha's Quant rating for Alibaba is currently standing at 3.17 [Hold].

Seeking Alpha Quant Ratings for Alibaba — Seeking Alpha Quant Ratings

In my opinion, an "A+" factor grade for profitability is a fair reflection of Alibaba's robust cash flow generation. Since Alibaba is no longer growing at rapid rates, I understand the "F" rating on growth. There are clear indications of weakness in the Chinese economy, and SA's data shows 25 downward revisions from analysts for this quarter (vs. eight upward revisions); hence the "C" rating on revisions makes a lot of sense. The stock has performed terribly over the last several quarters, and the momentum grade of "C-" is probably fair. Interestingly, Alibaba's factor grade for momentum has been improving in recent months (from D- to C-). Unfortunately, this improvement is a result of broader market weakness, and Alibaba remains stuck in the downward wedge pattern that we have discussed in the past.

Back in November 2021 (when I took a small position in BABA), I wrote the following:

After yesterday's post-ER drop, Alibaba's stock remains stuck in a downward wedge pattern. However, the stock is heading into a solid multi-year support zone of $125-135. A breakdown of this support could send Alibaba's stock into two digits. However, with Alibaba's accelerated share repurchases in Q2, I think the bottom may be very close.

WeBull
On the weekly charts, Alibaba is nearing oversold territory (RSI: 35) as it trades near a support zone, and the MACD looks ripe for a curl up after significant weakness over the last year or so. From a long-term perspective, I think this is a good entry point for investors.

And here's how the technical chart is looking today:

As of today, Alibaba is still stuck in the downward wedge pattern; however, there are signs of RSI divergence, and the MACD is also moving up slowly as the stock hovers above a demand zone (shown on the chart). While I do not see a trend reversal just yet, I think the technical setup is improving. A breakout to the upside could send Alibaba back up to $140-$150 in quick order. The lower end of the demand zone on technical charts is the all-time low of ~$57, which represents a downside potential of -30%. The potential upside is much greater than the potential downside. Hence, the risk/reward is very much in favor of the bulls.

Today, Alibaba's stock is trading at $82.50 per share ($235B in market cap), with the consensus analyst price target standing at $168.79 (upside of more than 100%). At ~9x P/FCF, Alibaba appears to be in the "value" territory, but let's deduce the absolute fair value to make an informed investment decision.

Is Alibaba Stock Undervalued Now?

To determine Alibaba's fair value, we will employ our proprietary valuation model. Here's what it entails:

In step 1, we use a traditional DCF model with free cash flow discounted by our (shareholders) cost of capital.
In step 2, the model accounts for the effects of the change in shares outstanding (buybacks/dilutions).
In step 3, we normalize valuation for future growth prospects at the end of the ten years. Then, we arrive at a CAGR using today's share price and the projected share price at the end of 10 years. If this beats the market by enough of a margin, we invest. If not, we wait for a better entry point.

Despite a slowdown in sales growth, Alibaba is still generating massive amounts of operational cash flows. If the macroeconomic environment worsens, we could see higher pressure on margins applying pressure on cash flow generation. According to consensus analyst estimates, Alibaba is poised to record ~$144B in revenues over the next 12 months; however, my estimate stands at $150B. In my view, Alibaba will command free cash flow margins of ~25% over the long term; however, I must warn you that this estimate may not materialize if the Chinese government hampers Alibaba's expansion into higher-margin industries like Cloud and Fintech. The other assumptions are pretty straightforward and self-explanatory.

Assumptions:

Forward 12-month revenue [A]	$150 billion
Potential Free Cash Flow Margin [B]	25%
Average diluted shares outstanding [C]	~2.755 billion
Free cash flow per share [ D = (A * B) / C ]	$13.61
Free cash flow per share growth rate	12.5%
Terminal growth rate	3%
Years of elevated growth	10
Total years to stimulate	100
Discount Rate (Our "Next Best Alternative")	9.8%

Here's the result:

Based on its fundamentals, Alibaba is worth ~$505 per share. As of writing, the stock is trading at ~$82.50, which means Alibaba is undervalued by ~80%. If Alibaba were allowed to conduct business freely in China, my assumptions would prove to be conservative. Therefore, Alibaba may outperform my projections.

To calculate the total expected return, we simply grow the above free cash flow per share at the aforementioned conservative growth rate, then assign a conservative Price-to-FCF multiple, i.e., 20x, to it for year-10. FYI, Alibaba was trading at a Price-to-FCF ratio of ~40x in early-2021. Here are the results for Alibaba's expected return:

As you can see above, Alibaba's stock price could grow from ~$82.50 to ~$1,105 at a CAGR of ~29.62% in the next ten years. Since these returns are significantly higher than my investment hurdle rate of 15%, I rate Alibaba a strong buy at $82.50 (there's a catch).

Conclusion: Is BABA Stock A Buy, Sell, or Hold?

While Alibaba is a great long-term buy based on its future free cash flow stream (DCF model), the quantitative and technical data do not support an immediate (significant) upside move post-earnings. As I clearly outlined in this note, I really don't know how Alibaba will perform in this quarter or how they will guide for the next quarter (if they do so at all). The consensus analyst estimate suggests a further slowdown in revenues and earnings, and the stock is pricing in a lot of weakness at ~8.55x P/FCF. Considering all of this, I don't think there's any need to be a hero here. I would rather look at the quarterly report and then make my capital allocation decision.

With that being said, I would most likely buy more Alibaba after the earnings report (until and unless the report is not horribly bad). At this price, I can't be bearish on a cash flow generating machine like Alibaba. The company has ~$77B of cash against ~$22B of debt (i.e., net cash of $55B) and a massive buyback program (worth $25B) in place, which makes me think that the downside from here can't be more than 25-30%. Hopefully, we get to see a good report, and the stock still tanks to all-time lows of ~$57 (~$165B market cap); I would love to build up a sizeable long position in Alibaba at those levels.

Key Takeaway: I rate Alibaba a strong buy at $82; however, I suggest waiting on the sidelines until tomorrow's report for deploying any fresh capital into Alibaba due to heightened uncertainty.

Thanks for reading, and happy investing! Please share your thoughts, questions, and/or concerns in the comments section below.

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This article was written by

Ahan Vashi

6.6K Followers

Ahan Vashi has 10+ years of investing experience with a professional background in equity research, private equity, and software engineering. He holds a Master of Quantitative Finance from Rutgers and a Bachelor of Technology in Electronics and Communication Engineering.

Ahan leads The Quantamental Investor, a community pursuing financial freedom through bold, active investing with proactive risk management. Features include highly-concentrated, risk-optimized model portfolios that meet investor needs across different stages of the investor lifecycle, access to proprietary software tools, and group chats. Learn more..

Analyst’s Disclosure: I/we have a beneficial long position in the shares of BABA 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.