I maintain my Buy rating for Alibaba Group Holding Limited's (NYSE:BABA) [9988:HK] stock at this time. BABA's shares currently represent a good buying opportunity in view of the stock's valuation discount relative to its peers, its long-term outlook relating to future share repurchases, and the cloud business' growth potential.
I previously raised my investment rating for BABA from a Hold to a Buy with my earlier Q2 FY 2023 (YE March 31) earnings preview article written on November 14, 2022. Alibaba's shares have risen by +63% since then, jumping from $73.16 to $119.44 as of January 24, 2023. Notably, BABA's share price went up by +33% in the past month.
In my opinion, the significant jump in BABA's stock price in the past month is mainly attributable to the easing of regulatory and political risks for Alibaba.
A January 4, 2023 Seeking Alpha News article mentioned that "Chinese regulators" have given the go-ahead for Ant Group to "raise $1.5B for its consumer finance unit." Two years ago, Ant Group, Alibaba's fintech business arm, aborted its public listing on the Shanghai Stock Exchange in November 2020, due to the company's failure to secure the necessary regulatory approvals.
On January 10, 2023, Reuters reported that BABA entered into "a cooperation agreement with the government of Hangzhou." Separately, the Cyberspace Administration of China took a stake in Alibaba's "media and entertainment units", UC Web and Youku, in the form of "golden shares" which offer voting power and the ability to appoint directors as per a January 13, 2023 Seeking Alpha News article.
As such, it is reasonable to view the recent developments for Alibaba and Ant Group as a sign that the crackdown on the Chinese technology sector has been halted by policy makers and regulatory agencies in China.
It is understandable that investors have applied a substantial regulatory risk discount to BABA's shares in the past. But Alibaba's stock has rebounded strongly in recent times thanks to a narrowing of this regulatory risk discount.
I deem Alibaba's shares to be undervalued, rather than fairly valued or overvalued, now.
BABA is still trading at a big discount to its Chinese internet peers, even though its shares have done pretty well in the last few months. The market currently values Alibaba at a consensus forward next twelve months' normalized P/E of 13.8 times as per S&P Capital IQ data. As a comparison, Tencent Holdings Limited (OTCPK:TCEHY) (OTCPK:TCTZF) [700:HK], Pinduoduo (PDD), and JD.com (JD) trade at forward P/E ratios of 24.7 times, 24.0 times, and 21.9 times, respectively.
Also, Alibaba used to command a forward P/E multiple in the 20-30 times valuation range (source: S&P Capital IQ) for most of 2020, before China began targeting the technology sector and related companies in late-2020. With the regulatory environment for internet companies in China turning more favorable, it is likely that BABA's forward P/E ratio can expand to 20 times or higher in time to come.
In the subsequent two sections of the article, I note that the likely absence of negative surprises when BABA announces quarterly earnings and the stock's good long-term outlook should support a positive re-rating of Alibaba's share price and valuations going forward.
Alibaba is expected to disclose its financial performance for the third quarter of fiscal 2023 (fourth quarter of calendar year 2022) on February 6, 2023. Expectations for BABA's Q3 FY 2023 results are low, and the market is already looking forward to Alibaba's business recovery in fiscal 2024 (April 1, 2023 to March 31, 2024).
The key metrics to pay attention to are the sell-side analysts' consensus Q3 FY 2023 and full-year FY 2024 revenue and bottom line estimates for BABA sourced from S&P Capital IQ.
The sell-side sees Alibaba's YoY top line expansion in local currency, or RMB terms, slowing from +9.7% for Q3 FY 2022 and +3.2% for Q2 FY 2023 to +1.9% in Q3 FY 2023. The analysts also predict BABA's normalized earnings per share or EPS to decrease by -2.1% from RMB16.87 in Q3 FY 2022 to RMB16.51 for Q3 FY 2023. This compares unfavorably with Alibaba's +15.4% bottom line growth (in RMB terms) in Q2 FY 2023. Moreover, 16 and 11 analysts (out of a total of 45 analysts covering the stock) have revised their Q3 FY 2023 top line and normalized EPS projections downward in the last three months.
BABA's business operations were very likely to have been adversely affected by the COVID-zero policy in Mainland China for the third quarter of fiscal 2023. But this is already reflected in the market's consensus financial figures for the stock. Therefore, I expect Alibaba to report in-line Q3 revenue and earnings next month.
More importantly, investors should be focused on the improvement in Alibaba's financial performance for the new fiscal year as BABA benefits from China's reopening. As per the analysts' consensus financial numbers, Alibaba's top line and normalized EPS are projected to increase by +11.9% and +16.2% to RMB982 billion and RMB60.90, respectively. The expected improvement in BABA's financial results for the new fiscal year are supported by a recovery in China's consumption, positive operating leverage, and the successful implementation of cost optimization measures.
In a nutshell, my view is that BABA's actual Q3 FY 2023 financial results and its forward-looking management commentary, to be revealed early next month, should be in line with the market's expectations.
I see Alibaba's stock continuing to do well in the long run, based on my evaluation of its cloud business' prospects and its capital allocation approach.
At its Q3 FY 2022 earnings briefing in February last year, BABA's CEO estimated that "China's cloud market will be a RMB 1 trillion ($150 billion) opportunity by 2025" because "industrial digitalization (in China) today is still in a very early stage."
The bullish comments made by the company's CEO regarding the long term growth potential of the Chinese cloud industry are supported by various research firms' forecasts and predictions.
McKinsey's research indicates that China's public cloud segment could expand by an impressive CAGR of +30% for the 2021-2025 period. Separately, Baillie Gifford's research team expects Alibaba to have close to a 50% profit share of the Chinese cloud market in 2026. In other words, digital transformation for companies in China should be a major growth driver for the Chinese cloud sector in the years ahead, while BABA remains as a key beneficiary as it is expected to still have a lion's share of the profits generated by this market.
Separately, Alibaba is generating a significant amount of free cash flow, and the company intends to allocate a meaningful proportion of its free cash flow to share repurchases. Sustained share buybacks should support a re-rating of BABA's valuations over time, as the market assigns a valuation premium to Alibaba for its shareholder-friendly capital allocation approach.
BABA increased the size of its share repurchase program from $25 billion to $40 billion in mid-November 2022 when it announced Q2 FY 2023 results. As of November last year, Alibaba still had around $22 billion remaining from its current buyback authorization which lasts until end-March 2025. In comparison, the sell-side analysts estimate that BABA can generate about $19 billion (in USD terms) of free cash flow for FY 2024.
Assuming that Alibaba completes its share repurchase program in full by March 2025, the company would have spent roughly half of its free cash flow on buybacks in the next two years which is pretty significant. Another way to assess BABA's share repurchases is to calculate the potential shareholder return yield. If the company allocates $11 billion to buybacks every year (half of what it is left of the buyback authorization for the next two years), this works out to be a very attractive shareholder return yield of 3.5% based on Alibaba's current market capitalization.
I continue to rate BABA's stock as a Buy. Alibaba's shares are undervalued, and I see its stock price rising on the cloud business' long term growth and the company's sustained share repurchases.
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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.