Investors are taking on political and geographical risks by holding China-based stocks. Although Alibaba Group (NYSE:BABA) is a giant with a market capitalization of over $440 billion, expect the stock’s volatility to increase. As U.S.-China trade talks resume, Alibaba stock will also move. Unless it creates a nice entry point in the $140 – $150 range, investors should not rush to buy the stock this month.
At the end of September, rumors circulated that the U.S. would consider de-listing China-based stocks. This rumor proved false, but it outlines the tense strain between the two countries. At best, investors should price in a discount on Alibaba stock for the scenario that the tariffs against each other will not change.
Strong Q3 Results Priced In Alibaba Stock
Alibaba stock rallied from around $150 to $180 after reporting strong Q2 results. Revenue grew 42% year-over-year, while non-GAAP free cash flow topped $3.8 billion. At its pace of active user growth, the company will probably reach 1 billion MAUs on mobile within the next few quarters. Clearly, its strong retail business, Ele.me and Alibaba Cloud are all growing at a strong rate. The U.S. tariffs against China are having virtually no impact on results. Since the Chinese consumer appears immune to foreign policy, investors may not need to worry much about the trade war.
But in reality, negative sentiment from the trade war is holding back BABA stock. Otherwise, the stock would trade in the $200 range. In the last quarter, Alibaba Group reported an adjusted EBITA loss from its cloud computing and digital media and entertainment units. These headwinds did not bother investors because the core commerce generates more than enough cash to offset investment and acquisition activities.
Strong Core Business
BABA continues to expect strong growth from its core business. The China retail marketplace is exhibiting strong user growth and user engagement. Alibaba is immediately investing profits from the business to invest in strategic businesses, such as local consumer services, digital entertainment and international marketplaces. The company’s approach to fostering growth is reliant on Chinese consumers and businesses. Its total addressable market will continue to expand, even as the U.S. tariffs loom. The ongoing strength of the Chinese economy should sustain Alibaba’s growth for the foreseeable future.
Alibaba Group has much of the consumer population in top-tier areas. Its next phase of growth relies on growing its customer base in the less developed areas. Users in this area have mobile devices so Alibaba’s penetration rate is high. As the company invests in the platform, the services, and the supply chain, it will fulfill customer orders in these areas with ease.
IoT and 5G on the Way
China is in the midst of upgrading its network to 5G. As the service comes online over the next two years, Alibaba Cloud will benefit. The service will handle more data transfers and will connect millions of users with a faster connection. This will lead to better services to customers as well as to enterprises. The faster connection on millions of devices will benefit the supply chain and the manufacturing channels. Supporting IoT will bring more business for Alibaba Cloud. So, this would suggest that the forward price-to-earnings ratio for Alibaba stock (~20X) is not realistic. The stock has room for P/E multiple expansion over the next few years. This suggests that investors buying the stock at current levels will get rewarded if they wait.
Alibaba Group may sustain revenue growth of at least 30% annually over the five years, at the low end of estimates. At this rate, a 5-year DCF Growth Exit model suggests the stock will have minimal upside (per finbox.io). Investors may more realistically expect revenue growth of at least 35-40% annually. At that rate, Alibaba stock is trading at a big discount.
As of this writing, Chris Lau did not hold a position in any of the aforementioned securities.