Alibaba Group Holding Ltd (NYSE:BABA) smashed second quarter revenue and earnings estimates last week, but BABA stock didn’t do all that much. It rose briefly to a high of $190 shortly after the open, but, by the end of the day, BABA stock had given up all those gains, and then some.
Some said that was the sign of the end for BABA stock. It had doubled already this year. The run was over. The China retail boom was winding down.
But those people clearly didn’t take a look at BABA’s numbers. Across all important metrics, BABA reported accelerated growth in the second quarter. Core commerce revenue growth ticked up. Cloud computing revenue growth ticked up. Annual active consumer growth hit double-digits for the first time in four quarters.
Clearly, the China retail boom isn’t winding down at all. In fact, it’s accelerating.
Consequently, the run in BABA stock isn’t over, either. BABA stock has bounced back and is now trading right around all-time highs.
I see another 25% upside. Here’s why.
Alibaba’s Growth Is Accelerating
At its heart, the Alibaba growth narrative is all about the China urbanization boom.
China’s middle-class is starting to urbanize at an unprecedented rate. Because China’s working class is significantly larger than America’s working class, there is tremendous growth potential, as Chinese consumers to start to act and spend like American consumers. Alibaba is at the forefront of this trend.
That’s the good news. The better news is that this trend isn’t slowing down. It’s actually still gaining momentum.
Alibaba’s core commerce revenues rose 45% last year. That accelerated to 58% growth in the first quarter of 2018, and then 63% in the second quarter of 2018. Most businesses that show such dramatic revenue increases experience a slow-down. Not Alibaba. It experiences a 40% tick-up in growth. That unusual strength underscores just how big the China urbanization boom is — and how long Alibaba’s growth runway is.
The accelerating commerce revenue growth is being driven by more consumers interacting on Alibaba’s retail marketplaces than ever before. Alibaba now has 488 million annual active consumers. Moreover, despite its massive size, Alibaba is actually seeing its net active consumer adds each quarter go up. Alibaba added 11 million active consumers three quarters ago, 12 million two quarters ago, and 22 million last quarter.
Again, this unusual growth acceleration underscores just how big Alibaba’s growth opportunity is.
And that is just the commerce side of things. Alibaba is also the leading cloud player in China. That growth narrative is also accelerating. Cloud computing revenues rose 96% in the first quarter of 2018. They rose 99% in the second quarter.
In fact, Alibaba Cloud is the fastest-growing major cloud platform in the world. With only 2.6% market share, Alibaba Cloud has a long runway for growth ahead of it.
With Alibaba, then, what you have is a company with accelerating growth in two rapidly growing markets. That is an excellent combination which should lead to BABA stock heading higher.
BABA Stock Is Greatly Undervalued
But how much higher can BABA stock go?
BABA stock trades at just 37 times fiscal 2017 earnings estimates of $5.04. I say “just” because earnings are expected grow about 30% per year from that $5.04 base to $8.46 in fiscal 2019. A 37 times multiple for 30% growth is very cheap. That is a price-to-earnings/growth (PEG) ratio of just 1.2.
To put that in perspective, the S&P 500 is trading at 19.7 times 2017 earnings for roughly 10.7% annual growth expectations into 2019. That is a PEG ratio of about 1.8.
As far as a price target is concerned, I think Alibaba stock will trend toward $235 over the next 12 months. From a fiscal 2018 earnings base of about $6.50, multiyear growth potential will look more like 20% (versus 30% from fiscal 2017). If you apply a market PEG of 1.8 to that 20% growth, you get a “fair” P/E multiple of about 36. A 36-times multiple on $6.50 fiscal 2018 earnings implies a one-year price target of just under $235.
Bottom Line on BABA Stock
All in all, this is an undervalued stock with an exceptionally strong growth narrative that is only getting stronger. Consequently, this stock will continue its solid uptrend over the next several months.
As of this writing, Luke Lango was long BABA and AMZN.
