Alibaba (NYSE:BABA) stock is having a rough start this month. Shares have fallen from $174.33 on Aug. 1 to $162.22 at the close of Aug. 8. With the U.S.-China trade war accelerating, investors are skittish about the company’s prospects.
But will the trade war materially impact the business of Alibaba Group? With BABA becoming increasingly tied to China’s domestic economy, they could be insulated from this macro risk. With shares taking a dip, the stock could be a buying opportunity.
However, growing competitors are an emerging threat. Long-term, this could reduce the company’s market power. So what’s the play with Alibaba stock? Read on to see whether investors should take a position, or wait for a better entry point.
Will Competition Impact Alibaba Stock?
As discussed in my July article, the company’s future is the Chinese middle class. Similar to Amazon (NASDAQ:AMZN) in the U.S., the company dominates e-commerce in China, holding a leading market share in its home market. Alibaba’s move into cloud services and entertainment is very similar to Amazon’s diversification in the United States.
However, Alibaba’s diversification efforts currently lose money. Amazon’s AWS unit generates most of AMZN’s operating income. But BABA’s cloud computing unit had an operating loss of RMB 164 million in the quarter ending March 31. Alibaba’s entertainment unit lost RMB 2.82 billion in the same quarter. The massive profitability of the retail unit (RMB 27.5 billion in quarterly operating earnings) allows Alibaba to take gambles with diversification.
But BABA is not the only e-commerce player in town. Rival JD.com (NASDAQ:JD) is catching up fast. As I wrote on Aug. 1, JD.com could unseat Alibaba as the “The Amazon of China.” JD’s e-commerce platform is a distant second to Alibaba, but JD.com has plenty of capital to scale. With partners such as Tencent (OTCMKTS:TCEHY), Alphabet (NASDAQ:GOOG,NASDAQ:GOOGL), and Walmart (NYSE:WMT), JD.com is a serious threat.
But the growing Chinese retail market leaves plenty of runway. Chinese e-commerce grew 23.9% in 2018. The Chinese online retail market is expected to hit $1.8 trillion in sales by 2022. This will make China’s retail market double the size of the U.S. market. Alibaba Group continues to show impressive sales growth. The move from an export-driven to a consumer-driven economy provides tremendous upside. But BABA stock could already be pricing in this potential. Let’s take a look at Alibaba stock’s valuation relative to peers. Do investors get a discount, or is the stock fairly valued?
BABA Stock Valued in Line With Peers
Alibaba stock currently trades with a forward Price-to-Earnings (P/E) ratio of 18.56. The company’s trailing twelve month (TTM) Enterprise Value/EBITDA (EV/EBITDA) is 25.5. Compare this to Amazon’s current valuation (54.3 times forward earnings, EV/EBITDA of 28.2). This makes Alibaba cheap on a P/E basis, but fairly valued on an EV/EBITDA basis.
Competitor JD.com trades at 26.1 times forward earnings, and has a TTM EV/EBITDA ratio of 64.2. Pinduoduo (NASDAQ:PDD) has both a negative forward P/E, as well as a negative EV/EBITDA ratio. JD.com is a more-apt peer to Alibaba, given Pinduoduo’s focus on the lower end of Chinese e-commerce.
While JD.com has a wider runway given its size relative to BABA, Alibaba stock is the better value. As Alibaba Group continues to lose money in cloud computing and entertainment, this diversification provides additional pathways to upside. In addition, while JD.com has the potential to usurp Alibaba as the “Amazon of China,” investors must pay a hefty premium for that opportunity.
Wait Until Earnings to Make a Move on Alibaba Stock
Alibaba Group releases earnings next week. With this in mind, it may be best to wait things out. It is tough to predict the outcome of the U.S.-China trade war. But Alibaba’s domestic growth continues to be a major catalyst. With the upcoming earnings report, investors can better assess the long-term potential of Alibaba stock.
With shares trading at a fair valuation, BABA stock is no bargain. High expectations continue to be priced into shares. But if the current headwinds continue, you may be able to enter a position at a better entry point.
As of this writing, Thomas Niel did not hold a position in any of the aforementioned securities.
