At the beginning of 2019, Alibaba (NYSE:BABA) stock was trading at $130. Amidst volatility, Alibaba stock is higher by 33.5% and currently trades $173.50.
Even after a significant rally, I believe that there is more upside for BABA in the coming quarters.
Even if China’s slowdown factor is discounted, Alibaba is likely to grow at a robust pace and the stock remains undervalued.
Core Commerce: The Revenue and EBITDA Driver
Alibaba has diversified into cloud computing, digital media & entertainment and other innovation initiatives. However, the core commerce segment is likely to remain the key revenue and EBITDA driver.
To put things into perspective, all other business segments reported negative EBITDA for FY19 except the core commerce segment. Further, for FY19, the adjusted EBITDA margin from core commerce was robust at 42%.
The single biggest driver of core commerce in China is likely to be a swelling middle class. China’s population is 1.4 billion and it is estimated that nearly 400 million people are already in the middle-class segment. That’s larger than the population of United States!
China’s GDP growth has decelerated. However, even if China grows at 5% to 6%, the standards of living will continue to rise. This presents an immense opportunity for Alibaba in the coming years.
The point I am making is made evident by core commerce revenue surging by 51% in FY19. Even at a high revenue base, growth has been stellar as the market remains under-penetrated. Further, the “6.18” mid-year shopping festival broke records across China, providing critical insights into BABA’s growth. Cities outside first- and second-tier were among the top ten in terms of GMV. As Alibaba penetrates into smaller cities, core commerce growth will remain robust.
From a macro-economic perspective, China has production and manufacturing excesses. With a slowdown in the manufacturing sector, the focus will be on the consumption sector to trigger growth. Any potential government stimulus in the foreseeable future to trigger growth will target the consumption sector.
Therefore, being the biggest player in China, Alibaba is well positioned to sustain growth in core commerce. This will keep momentum positive for Alibaba stock.
Attractive Valuations
Core commerce growth is the key upside trigger for BABA stock. In addition, shares of Alibaba trade at a valuation gap to its closest peer. This is another reason to believe that there is more juice in the current rally.
Alibaba trades at a forward price-earnings (P/E) of 26.2. On the other hand, JD.com (NASDAQ:JD) trades at a forward P/E of 45.3.
It is important to note that Alibaba reported diluted earnings per share (EPS) of RMB 33.38 for FY19 as compared to a diluted EPS of RMB 24.51 for FY18. This implies earnings growth of 36%.
If earnings growth sustains above 30% for FY20, Alibaba is trading at a PEG of less than 1. This clearly implies that the stock is undervalued as compared to its growth visibility.
Uncertainty related to economic growth and trade war has kept the stock relatively depressed. However, the consumer sector in China has significant impending growth and Alibaba will deliver robust numbers.
India Can Be a Game Changer
China is home to nearly 1.4 billion people with a swelling middle class. India is also home to 1.3 billion people with sustained growth in standards of living.
Amazon (NASDAQ:AMZN) and Walmart (NYSE:WMT) have made significant inroads in India’s e-commerce market.
While Alibaba has not been successful with some investments in India, the e-commerce giant is looking towards a strategy shift. The idea is to pursue smaller deals and make vertical e-commerce investments.
I believe that with robust financial flexibility, Alibaba can still make inroads in the Indian market. That will give Alibaba access to another big growing market after China.
It is also worth mentioning that Alibaba has some successful investments in India. This includes BigBasket and Zomato. The grocery e-tailer (BigBasket) is likely to have a current valuation of $1 billion. HSBC estimates that Zomato has valuation of $3.6 billion.
Leading the pack is the online payment services company, Paytm. The company has also seen investment from Berkshire Hathaway and the valuation is pegged at $16 to $18 billion.
While these investments will unlock real value in the long-term, it keeps Alibaba interested in another big emerging market with potentially a billion consumers.
Bottom Line on Alibaba Stock
Core commerce segment will remain a key stock upside trigger for Alibaba in the coming quarters. Further, investment in cloud computing and innovation can potentially be a long-term value creator.
With the factors discussed, I believe that Alibaba stock can trend higher and valuations make the stock a compelling buy with a medium to long-term investment horizon.
As of this writing, Faisal Humayun did not hold a position in any of the aforementioned securities.
