Over the past few months, the stock price of Alibaba (NYSE:BABA), one of the most important Chinese companies to be listed on U.S. exchanges, has been extremely choppy as the rhetoric on U.S.-China trade issues has become the elephant in the room.
It’s probably the understatement of the past 12 months to say that the trade war between the U.S. and China have brought significant uncertainty to the global stock markets. As a result, most Chinese stocks are currently much cheaper than they were a year ago.
Now that the meeting between President Donald Trump and the Chinese President Xi Jinping at the G20 summit is over, investors will turn their attention to the Federal Reserve’s interest rate decision as well as the upcoming earnings releases by many tech heavyweights. Therefore, the recent volatility we have experienced, especially in the tech sector, is likely to stay with us for a while.
Today let us discuss BABA stock in light of the developments in China as well as South and South East Asia.
The Chinese Economy Is Growing and Evolving
Over the past two decades, Alibaba has become a highly regarded global company, and BABA stock offers U.S. investors the chance to invest in the growing Chinese consumer and e-commerce markets.
Although the Chinese economy may slow down in 2019 or even 2020, its GDP is still expanding at an average annual rate of 6% minimum. This growth is indeed faster than almost any other major economy in the world. With a population of almost 1.4 billion people, China’s economic growth is still in its early stages and the Chinese middle class is likely to expand for a long time.
About 20% of the country’s retail purchases are made online. In 2018, the online retail sales of goods and services was over $1.3 billion, up by 23.9% year-on-year (YoY). Readers who are interested in various statistics on China may want to refer to the website of the National Bureau of Statistics of China.
In other words, China’s growing middle class will continue to drive increases in the country’s consumer spending. And when average Chinese citizens have more money in their pockets, more of it can be spent on online shopping sites like Alibaba, which itself is a good proxy for levels of retail spending in China.
Furthermore, many analysts believe that BABA stock’s bottom line is not going to be too adversely affected by current trade wars, as its business model is tied to China directly, decreasing the long-term risks of bi-party trade wars.
This fact may indeed be important for long-term Alibaba shareholders, as in general the trade war has had a negative impact on investor sentiment as well as on the prices of many tech stocks. After all, the U.S. is still China’s biggest trading partner, as it buys almost one-fifth of its exports.
As weeks go by, not many analysts believe that the U.S. and China are likely to conclude a comprehensive trade agreement soon. The negotiations may well drag out right up to the U.S. presidential elections.
Yet, BABA stock may prove quite resilient to further news on the trade disputes, especially as one headline is usually reversed in a few days by usually an opposite headline. Alibaba’s management has also downplayed the potential adverse effects of the trade war on BABA stock. Soon, markets may stop caring much about the news on the trade rhetoric.
How Does Alibaba Stock Make Money?
Alibaba is expected to release its next earnings statement on Aug. 22.
When BABA stock released its most recent quarterly results on May 15, both sales and earnings exceeded estimates. Total revenue came at $56.1 billion, an increase of 51% YoY. On the bottom line, BABA stock grew adjusted net income by 12%. In fiscal 2020, management expects Alibaba’s revenue to top $72 billion, a 33% YoY growth.
In the most recent quarterly statement, analysts have paid attention to four main areas:
- Core commerce (BABA’s largest segment, whose revenue grew 54% YoY);
- Cloud computing (revenue soared soared 76% YoY);
- Digital media and entertainment (revenue increased 8% YOY); and
- Innovation initiatives (revenue jumped 22% YOY).
Despite the company’s dominance in the Chinese e-commerce space, Alibaba is also rapidly expanding into many other lucrative industries aside from consumer products and retail. These segments include cloud computing infrastructure (i.e., Alibaba Cloud), digital payments (i.e., Ant Financial Services Group), online entertainment (i.e., Youku Tudou and Alibaba Pictures), and food delivery (i.e., Alibaba Local Services Company which is a merger between Ele.me and Koubei).
Alibaba also owns over 31% of Weibo (NASDAQ:WB), the Chinese microblogging company. Chinese internet celebrity (better known as “wanghong“) accounts at Weibo, and the website’s rich multimedia functionalities help make WB a much-loved and somewhat indispensable social media company within China. Furthermore, WB’s recent investments in live video streaming and fintech have already started contributing to the bottom line.
Although many analysts have expressed growth concerns regarding China in the coming quarters, the country’s economic fundamentals have vastly improved over the past decade. The internet population is still booming and money continues to pour into Chinese companies operating in this space — factors that help support the long-term durability of BABA stock.
BABA Stock Has Robust Fundamentals
Alibaba has been branching out into other business ventures, and this expansion has been made possibly partly by its steady free cash flow (FCF), which measures a company’s ability to produce cash. Investors care a lot about FCF, as it can be used in a discretionary manner. For example, BABA has used its FCF to invest in growth opportunities and strengthen its balance sheet further.
Therefore on Aug. 22, Wall Street is likely to analyze the company’s cash position closely. Many analysts expect Alibaba’s revenue to continue growing by double-digit-percentage rates.
In general, Alibaba’s management does not provide any earnings guidance for future quarters. But there is general consensus that BABA’s top line can increase at an average annual rate of 20%, through both organic growth and acquisitions. That would be an impressive growth rate for a company with a market cap of $452 billion.
Another metric to pay attention to in August is Alibaba’s operating margin, which stood at roughly 18% as of the end of the first quarter. Over the years, BABA’s high operating margin has contributed to its profitability, which has been even higher than that of Amazon (NASDAQ:AMZN).
However, investors are concerned that Alibaba’s profit margins are decreasing. In fact, they are at their lowest levels since the company went public in September 2014. The group’s various investments in especially cloud, digital media and food delivery have been pressuring profits. Although these new ventures help BABA expand its ecosystem, they also weigh on the stock’s profitability, as these other segments are not yet profitable. The current profit margin stands at 27.7%.
Alibaba Stock Is a Leader in E-Commerce
At present, the company’s share of the Chinese e-commerce space is over 55% and BABA’s core business of online retail contributes to about 85% of revenues.
In comparison, Alibaba’s closest rival, JD.com (NASDAQ:JD), has about 16% share of the Chinese e-commerce space. On the other hand, in 2018, Amazon’s share of online retail marketplace was less than 1%; as a result Amazon is now closing down its Chinese online market.
BABA operates through three main ecommerce sites — Taobao, a Chinese online shopping website; Tmall, a Chinese-language website for business-to-consumer online retail; and Alibaba.com, the group’s international trade site. The three sites have hundreds of millions of users globally and host millions of businesses.
Alibaba’s mobile Monthly Active Users (MAUs) on its e-commerce platforms is now 721 million. Alibaba’s core business of e-commerce is highly profitable, as it charges a commission on items sold. The group also sells advertising on its platforms.
Alibaba uses Gross Merchandise Volume (GMV) to measure total sales transacted through its platforms. For fiscal 2019, Alibaba’s commerce business generated $853 billion in GMV, especially led by the Tmall retail marketplace. GMV on Tmall and Taobao have also increased by 31% and 19%, respectively.
It is important to remind our readers that many U.S. companies already use Alibaba’s platforms to reach consumers in China, a market that’s competitive yet attractive. And the group is aiming to increase its reach further and have more American business list their products on the company platforms. When Alibaba reports in August, BABA shareholders will be interested to analyze the corresponding MAU and GMV numbers.
Earlier in 2019, the International Monetary Fund (IMF) warned that China, the world’s second-biggest economy, is likely to be slowing down in the rest of the year. However, the e-commerce market in China is still forecast to almost double within the next four years to reach $1.8 trillion. Therefore, even if the Chinese economic growth pauses for a few quarters to come, the country’s growth potential is intact.
In other words, a potential cooling off in China shouldn’t get in the way of a sensible, long-term investing strategy, which BABA stock may offer shareholders.
BABA’s Cloud Segment Is Growing
With a population of nearly 1.4 billion people, China is the largest country in the world. A rising middle class leads to higher consumerism, and that bodes well for many industries in China. One of those industries set to benefit is cloud computing.
On May 15, when BABA released its quarterly results, both sales and earnings exceeded estimates. Investors cheered that BABA’s cloud computing revenue soared 76% YoY.
As a result of increased diversification as well as the growth in the cloud space, Alibaba’s total revenue is expected to grow by double-digit-percentage rates. Such a growth rate would indeed be impressive for a company with a market cap of $415 billion.
Alibaba is now offering data analytics services to third-party businesses through A100, which integrates consumer shopping data into merchants’ other services. The data is also becoming increasingly personalized through the use of artificial intelligence (AI). For example, Nestle (OTCMKTS:NSRGY) and Starbucks (NASDAQ:SBUX) have already started using this data analytics service offered by A100. Other merchants have started linking facial-recognition data to A100 so that they can offer personalized solutions to customers as soon as they enter the store.
Ant Financial and Alibaba’s Fintech Ecosystem
The global payments industry is a $100 trillion plus market. And the financial technology (fintech) apps revolution is quickly changing the way traditional banks, credit-card issuers and mobile-payments companies work with businesses as well as their retail customers.
Ant Financial Services Group, formerly know as Alipay, is Alibaba’s mobile and online payment platform. Alibaba has a 33% stake in Ant Financial, which is an extremely popular mobile payment platform throughout China.
The company processes payments between any two users. It further offers a wide range of financial services, such as insurance, credit, loans, credit scoring, and wealth management.
China is witnessing the tremendous growth of fintech. At present, Ant Financial and Tencent, Alibaba’s biggest rival in this sphere, control about 90% of China’s payments market.
Alibaba Is Growing Internationally
Finally, forward-looking investors may want to pay attention to BABA’s international growth numbers, too. Currently, more than 90% of the e-commerce giant’s sales are made in China. But BABA has investments in start-ups in South Asia and Southeast Asia, too.
Southeast Asia is en route to becoming the world’s fourth-largest economic region by GDP, and analysts expect its e-commerce sector to expand tremendously within the next decade. Higher incomes and rising internet penetration rates are likely to strengthen these regions’ e-commerce markets.
Aibaba’s focus on India is an area that investors may want to pay attention to for the long run. Globally, India is the fastest growing e-commerce market where the annual growth rate is about 50%. Increased smartphone usage as well as advances in delivery infrastructure and logistics are contributing to the increase in revenue. In addition to Paytm, Alibaba has also invested in Big Basket and Zomato in India.
BABA is also looking to partner with European companies. Many European companies are still discovering new ways to enter the Chinese market, and BABA may enable them to connect with Chinese customers faster. Ant Financial is also seeking to expand in Europe.
International growth will not only help increase the company’s bottom line, but it will also enable BABA to diversify away from China, lowering the country-specific macro risk of Alibaba stock.
BABA Stock’s Upcoming Listing in Hong Kong
By the end of year, Alibaba is possibly going to Hong Kong for a second listing. There the company is expected to raise $20 billion.
BABA had delisted from Hong Kong in June 2012. Now there is speculation as to why the company wants to move closer to China in a second listing and raise cash. Both the bulls and the bears are debating Alibaba’s motives.
Is it because BABA management is worried about the trade wars? Can BABA’s second listing encourage more Chinese companies to follow Alibaba to Hong Kong? Does Alibaba need the cash for reasons investors do not know yet? Should investors therefore be worried?
The exact result of this listing is still hard to pin down. For example, Alibaba has recently announced a one-to-eight stock split. A lower price may lure more Hong Kong-based investors into buying Alibaba stock.
However, we do not know how its U.S. shareholders may react. One thing we can probably count on, though, is increased volatility in BABA stock price.
Short-Term Technical Analysis for BABA Stock
As a result of the impressive run-up of Alibaba stock since early June, BABA’s short-term technical indicators have become overextended. Therefore, in July BABA stock has been impacted by profit-taking as it heads into its earnings report season.
In the next few weeks, I do not expect BABA stock to regain its recent high of $195.72, which was last seen on May 3. At this point, bulls are not yet in control. Therefore Alibaba shares will need a strong catalyst to make them attractive in the eyes of long-term investors. Instead, depending on headlines regarding the U.S.-China trade war or the interest rate decision by the Fed, I expect BABA stock to trade between $155 and $175.
In other words, at the current price of about $167, I find the risk/reward ratio on the long side inadequate. I would not advocate bottom-picking in case of near-term price weakness, but I’d be ready to start building a position around $155 later in the summer.
It’s almost impossible to time a top and a bottom in the markets. Those who bought at about $195 in early May might not be too happy, but investors who had the courage to step in at the end of 2018 or on the last day of May 2019 are in pretty good shape.
If you are an investor with paper profits, maybe you should consider locking in some of those gains now. That said, if you are worried about profit-taking in the short term , then within the parameters of your portfolio allocation and risk/return profile, to protect your profits to date, you may consider placing a stop-loss at about 3%-5% below the current price point.
In case of a potential profit taking, short-term moving averages and oscillators would move toward a more neutral reading from the overbought levels we are currently seeing. And long-term investors may prefer to open up positions then.
In other words, if you are not yet a shareholder of BABA stock, you may want to wait on the sidelines until you have had a chance to analyze the earnings results.
If you already own BABA shares, you may consider hedging your position with at-the-money (ATM) covered calls with Aug. 16 or Sept. 20 expiry.
The volatility of Alibaba stock is high, giving it a broad trading range, so short-term traders should proceed with caution.
BABA Stock’s PEG Ratio
In addition to looking at technical analysis charts, I keep an eye on stocks’ Price/Earnings to Growth (PEG) ratio. A PEG ratio of one means the market’s perceived value of the stock is equal to its anticipated future earnings growth. For example, if a stock had a P/E ratio of 25, and the company’s projected earnings growth was 25%, then the PEG ratio would be one.
With the PEG number, investors can compare and contrast the relative value of a stock against other stocks. I also compare the change in PEG with the change in a stock’s price within a given time-frame to gauge investor sentiment regarding a stock’s potential price increase.
In 2019, Alibaba stock is up over 20%. Given BABA’s current level of earnings growth, Alibaba’s PEG of 1.33 is currently high from my perspective. In other words, I regard BABA’s stock price of about $167 as somewhat over-stretched. However, please remember that the PEG ratio is just one tool in investors’ arsenal.
The Bottom Line on BABA Stock
Alibaba stock offers U.S. investors the chance to invest in the growing Chinese consumer and e-commerce markets. As the company’s second decade ends, it is increasingly focusing on becoming a social hub. Alibaba’s growth in e-commerce, cloud computing and other investments throughout China and globally make it a disruptor and a sound long-term investment.
BABA stock is a fundamentally sound stalwart investment in China as well as in the neighboring regions with further growth prospects, profitability, leadership, stability and proactive management — factors that are likely to translate into a strong balance sheet and robust bottom line in the rest of the decade.
I also believe that most of the negative effects of the U.S.-China trade war have already been priced into Alibaba stock. If the two sides reach a deal that’s seen in a positive light this year, BABA stock is likely to rally.
The month of June has given Wall Street a glimpse of how powerful BABA’s comeback could be: the stock rallied from an intraday low of $147.95 on May 31 to an intraday high of $177.95 on July 1.
Therefore long-term investors should possibly view any decline in BABA stock as a good opportunity to get into Alibaba shares. However, traders with a short-term horizon should remember that there might be some profit-taking in the stock ahead of BABA’s earnings in August.
Investors who are interested in buying into Chinese companies, but do not want to commit all their capital to a single stock such as Alibaba may also consider investing in various exchange-traded Funds (ETFs) that have BABA as a holding, including iShares MSCI China ETF (NASDAQ:MCHI), KraneShares CSI China Internet ETF(NYSEARCA:KWEB) or iShares Core MSCI Emerging Markets ETF (NYSEARCA:IEMG).
As of this writing, Tezcan Gecgil did not hold a position in any of the aforementioned securities.