The U.S.-China trade war started in late January 2018 when U.S. President Donald Trump announced tariffs on solar panels and washing machines from China. That means that the trade war is now about 19 months old. Over those 19 months, the trade war has claimed its fair share of victims. One of those victims has been China’s biggest technology company — Alibaba (NYSE:BABA).
In late January 2018, Alibaba was nearly a $200 stock. Today, Alibaba stock trades hands around $170. Thus, during the 19 months of the U.S.-China trade war, Alibaba stock has shed more than 10% while the S&P 500 is actually up about 2% over that same stretch.
In other words, Alibaba stock has been a big victim of the U.S.-China trade war. It will continue to be a victim for the foreseeable future, meaning that so long as the trade war hangs around, Alibaba stock will likely remain weak. It will be “chop” — which is finance slang for saying that Alibaba stock will be volatile, and ultimately go nowhere.
Investors shouldn’t be discouraged by this chop. Instead, they should embrace it. Long term, this stock is going to fly higher, and this near-term chop is nothing more than a long-term opportunity to buy at a discount.
There are three big points supporting the bull thesis on Alibaba stock here and now. Those three points are as follows.
China’s Macro Fundamentals Are Improving
Starting from the top, the first big reason to embrace the chop in Alibaba stock is that — underneath the trade war headlines and noise — China’s economy is finally starting to turn a corner.
Since early 2018, China’s economy has meaningfully slowed — so much so that GDP growth has fallen to multi-decade lows. But, multiple data points have emerged over the past few months which, in sum, imply that this slowdown is easing, and will be replaced by economic acceleration soon.
Specifically, the OECD’s Composite Leading Indicator (or CLI) for China — which compressed for most of 2018 — has expanded every month from February through June 2019. The OECD’s Consumer Confidence Index (or CCI) for China — which similarly compressed throughout 2018 — has also rebounded in 2019. Retail sales growth in China has improved from 8.1% to 8.2% in late 2018, to an average gain of 8.7% over the past three months. China’s Purchasing Manager’s Index (PMI) reading compressed rapidly throughout 2018, but has shown signs of stabilizing between 49 and 50 in 2019. China trade data is similarly stabilizing, and June trade data was much better than expected on both the imports and exports side.
Overall, then, it appears that China’s economy is on the cusp of not just stabilizing, but potentially even improving over the next few quarters. That’s a positive read for Alibaba stock, since as goes China’s economy, so goes Alibaba’s revenue growth rates. Thus, if China’s economy is indeed turning a corner, then Alibaba’s decelerating revenue growth trajectory of 2018/19, may turn into an accelerating one in 2020/21.
Alibaba’s Margins Are Improving
Truth be told, revenue growth has never really been a problem at Alibaba. This company has fired off 40%-plus revenue growth rates for as long as anyone can remember, as Alibaba has found itself at the epicenter of explosive growth throughout China’s digital economy over the past decade.
Margins, however, have been a problem at Alibaba for a long time. Specifically, in order to fully capitalize on its growth opportunity in the explosive China digital economy, Alibaba has had to invest big into expanding its operations over the past several years. These big investments have powered consistent 40%-plus revenue growth. But, they’ve also eroded margins. At the end of fiscal 2016, Alibaba’s trailing twelve month profits margins were north of 40%. They fell below 25% by the end of fiscal 2019.
But margins are finally starting to improve. That is, Alibaba’s big growth investments over the past few years, are starting to phase out, while its big growth businesses (like cloud) are starting to mature and rationalize. The result is that the margin trend has consistently improved over the past few quarters, and in the first quarter of fiscal 2020, trailing twelve month margins actually rose sequentially – the first time they had done so since early fiscal 2018.
This margin improvement trend is here to stay. That means sustained big revenue growth — supported by favorable China digital economy fundamentals — will be joined by margin expansion, which will power robust profit growth over the next several years. That robust profit growth should power Alibaba stock higher.
Alibaba Stock Has Huge Growth Potential Long Term
The math for Alibaba stock to head higher in the long run isn’t too hard to follow.
This is a company which, for most its life as public company, has reported 50%-plus revenue growth. Those growth rates are finally starting to slow into the 40% range. They will continue to slow over the next several years as China’s digital economy slows. But, China’s digital economy will remain a big growth market for a long time, given that China’s internet penetration rates, per capita incomes, per capita expenditures, and e-commerce spend per capita are all still well below developed economic norms, and that the China government continues to abundantly supports its technology sector.
As such, Alibaba very reasonably projects as a 20%-plus revenue grower for the foreseeable future. As stated earlier, margins should start to run higher alongside that 20%-plus revenue growth, so profit growth should run north of 25% — at least.
Conservatively, that would peg Alibaba’s 2025 EPS at $20. Based on a growth stock average 20-times forward multiple, that implies a 2024 price target for Alibaba stock of $400 — more than double today’s price.
Bottom Line on BABA Stock
So long as the trade war hangs around, Alibaba stock won’t stage a meaningful and sustainable move higher. But long term, this stock has tremendous upside potential — so this near-term chop is nothing more than a long term buying opportunity.
Patience, of course, is required — but it will also be rewarded.
As of this writing, Luke Lango was long BABA.
