When the U.S. backed off from imposing tariffs on Mexico, investors became more optimistic about the Trump administration reaching a deal with China. So it’s not surprising that China-based stocks have rallied nicely in the last week, enough to suggest that investors should look at them again.
Alibaba’s $20 Billion of Extra Liquidity
On May 28, Reuters reported that Alibaba would raise $20 billion through a Hong Kong listing of Alibaba stock. The additional liquidity gives the e-commerce giant some insurance against risks associated with the U.S.-China trade war. If BABA delists Alibaba stock from the U.S. market, it will still have plenty of cash on its balance sheet, and BABA stock will still be publicly traded, albeit in Hong Kong.
Listing Alibaba stock on the Asian exchange also prevents Americans’ animus towards China from holding down the valuation of all BABA stock. In New York, Alibaba stock trades at a forward price-earnings ratio of 18.6, even though analysts, on average, expect its earnings per share to jump 36% this year.
Alibaba does not need the $20 billion from listing Alibaba stock in Hong Kong. At the end of last quarter, (BABA’s fiscal fourth quarter) the company had cash, cash equivalents, and short-term investments of $28.8 billion. To increase shareholder value, the company bought back 10.9 million shares of Alibaba stock for $1.6 billion. Looking ahead, Alibaba expects its top line in FY 2020 to come in at $28.9 billion (RMB 500 billion). Expect the company to use some of its cash to buy back more shares of Alibaba stock this year.
Solid Q4 Earnings Growth
In Q4, Alibaba’s total revenue jumped 51% and its EPS came in at $1.20, outpacing analysts’ consensus estimate by 33 cents. The company will become more profitable as its innovative initiatives strengthen its digital media, entertainment, and cloud-computing businesses.
Instead of buying Amazon.com (NASDAQ: AMZN) stock to gain exposure to the growth of Amazon’s cloud business, investors can buy Alibaba stock, which has a much lower price-earnings multiple than AMZN stock. BABA’s cloud-computing revenue surged 76% last quarter, and Alibaba is the leading cloud service provider in China and faces no real competition there. Conversely, Amazon.com’s AWS may eventually face growing competition from Microsoft’s (NASDAQ: MSFT) cloud business, Azure.
To convince investors that Alibaba’s cloud business will eventually meaningfully raise its bottom line, the unit must first report positive EBITDA margins. Although the unit’s EBITDA was negative 2% in Q4, that’s an improvement over the negative 8% it posted during the same period last year. Still, more customers are signing on to Alibaba Cloud, and the unit’s operational costs will fall as its revenue rises Meanwhile, Alibaba generated $1.6 billion in non-GAAP free cash flow despite its investments in Alibaba Cloud.
Alibaba Stock Is Undervalued
Alibaba stock should trade closer to its 52-week high of $211. Instead,BABA stock price is around $161. Investors are still discounting Alibaba stock instead of rewarding it for the continued growth of Alibaba’s customer base. In Q4, its customer base surged 77% year-over-year. Markets are clearly nervous about the U.S.-China trade war. But BABA’s China retail business will likely continue to grow, despite the ongoing macro headwinds.
On June 11, China’s local governments introduced new stimulative infrastructure spending initiatives to offset the impact of U.S. tariffs on the Chinese economy. BABA’s China-based businesses should be relatively resilient to the trade war, so the stimulus should cause the company’s revenue growth to accelerate in the next few quarters.
Valuation and the Bottom Line on Alibaba Stock
There’s little reason to doubt that BABA’s revenue growth will be at least 20%. Based on a 5-year DCF Growth Exit model, Alibaba stock has a fair value of over $200 per share.
BABA stock price bounced back from $150 to almost $161 in June. As investors speculate on the U.S.- China trade talks slated to take place at the next G20 meeting at the end of this month, expect the rebound of BABA stock price to continue.
As of this writing, the author did not own shares of any of the companies mentioned in his column.