Shares of Chinese e-commerce giant Alibaba (BABA) are down 13% from their late-May highs. Among the factors that have weighed on the shares are the recent sharp decline in the Chinese stock market and worries about the Chinese economy.
But there are signs that the Chinese economy is rebounding, and the pullback in Chinese stocks isn’t likely to wreck the country’s economy. Consequently, for investors with a time horizon of at least six months and the ability to withstand some volatility, BABA stock looks like a good pick at current levels.
BABA stock is trading at around 22 times forwards earnings, but EPS are expected to grow 33% in 2016, making it relatively cheap, given its growth.
Moreover, BABA is undertaking several initiatives that could cause its profits to beat expectations by large amounts.
Opportunities for BABA Stock
Alibaba is in the process of creating its own version of Netflix (NFLX) and HBO, and it is seeking to expand its e-commerce business to 11 countries outside of China, including the U.S., Britain, Spain, Turkey, Malaysia and Singapore.
Alibaba has also taken a majority stake in a movie production company, and it has large stakes in an array of tech start-ups, including up and coming social media app Snapchat and video game maker Kabam, which was valued at $1 billion a year ago.
If BABA creates the Chinese version of Netflix, and/or become a meaningful player in e-commerce in other countries, its profits will rise by significant amounts. In 2014, Netflix had net income of $267 million. If Alibaba’s version of Netflix generates a similar profit, the e-commerce giant’s overall profit, which came in at $3.9 billion in 2014, would rise by 6.8% from that level.
More significantly, if Alibaba can create successful e-commerce businesses in large countries outside of China, including the U.S., its profits will obviously rise by much bigger amounts.
Outlook for Chinese Stocks
Of course, the elephant in the room is the slide in Chinese stocks. Despite the huge retreat in the country’s stocks, it does not appear that the growth of the Chinese economy is about to massively decelerate. Consequently, the stock market slide should not be a significant threat to BABA’s profits.
Chinese stocks aren’t a huge portion of the country’s economy. Stocks represent only 15% of Chinese households’ financial assets, and most companies don’t rely on stocks as a source of financing, HSBC’s chief economist for Greater China Qu Hongbin wrote on July 7, according to Business Insider. Moreover, most of the country’s banking sector isn’t “imminently linked ” to stocks, the website quoted Qu as saying.
Moreover, China’s economy doesn’t seem to be tumbling. The country’s official Purchasing Managers’ Index came in at 50.2 in June, slightly above the 50 level that separates contraction and expansion. It was unchanged from the previous month. China’s official purchasing managers’ index for the services sector increased to 53.8 last month from 53.2 in May,
HSBC’s June manufacturing PMI for June was less positive, coming in at 49.4. But that was up from 49.2 in May.
Furthermore, China’s prime minister was fairly upbeat on the country’s economy recently, according to China Daily. The country’s “major economic indicators have stabilized,” and positive signs are emerging, Li said.
And, contrary to what some may think, Li has not always been a cheerleader for the economy. In March 2014, he warned that the economy was facing perils, amid “heightened pressure to arrest the pace of economic slowdown,” Forbes reported at the time.
Bottom Line for BABA Stock
So the valuation of BABA stock is attractive, it has many significant growth opportunities, and the company’s profits won’t be derailed by a huge deceleration in China’s economic growth.
But it may take time for investors to digest the idea that a decline in the bubblicious Chinese stock market won’t endanger the e-commerce giant’s profits. So only long-term investors who can accept volatility should buy BABA stock.
As of this writing, Larry Ramer did not hold a position in any of the aforementioned securities.
