It is worth noting that Alibaba (NYSE:BABA) has traded sideways for almost eight months. I see this as a golden opportunity to accumulate the stock. Alibaba stock currently trades at a forward PE of 24.6 as compared to a forward PE of 34.5 for JD.com (NASDAQ:JD).
Considering the valuation gap, it would not be surprising if BABA stock trades above $250 in the next 12-18 months. Within the eCommerce segment, the demand for luxury brands by consumers is likely to be a game-changer for Alibaba.
China Luxury Report 2019 by McKinsey & Company provides an insight into the potential market size. According to the report – “China delivered more than half the global growth in luxury spending between 2012–18, and is expected to deliver 65 percent of the world’s additional spending heading into 2025.”
In terms of numbers, Chinese consumers will spend $1.2 trillion on luxury goods by 2025.
Another report from Bain & Capital points to an important fact. “China’s luxury sales outgrew overall markets in 2018, but online penetration remains low – except in cosmetics.”
Without any doubt, this is a huge opportunity for Alibaba and other e-commerce companies in China.
Alibaba and Brand Acquisition
With a big opportunity in hand, Alibaba is going aggressive in terms of having top luxury brands on its eCommerce platform.
As of March 2019, the company’s Tmall Luxury Pavilion had more than 100 luxury brands. As Bloomberg reports, Alibaba is targeting to double the number of brands to 200 by March 2020.
In addition, the company has also pursued the inorganic route to accelerate growth. Alibaba acquired Kaola from Chinese gaming company NetEase (NASDAQ:NTES) for a consideration of $2 billion.
According to data (1Q19) from DragonSocial, Tmall had a 25% market share in China’s cross border e-commerce. However, Kaola was the market leader with 27.5% market share. With the acquisition, Alibaba has more than 50% market share in China’s cross border e-commerce market. JD.com had a market share of 13% for the same period.
Considering the market potential, JD.com is also looking to gain market share. The company has partnered with Farfetch (NYSE:FTCH) to attract luxury shoppers. However, Alibaba does have an edge and the acquisition of Kaola can be a growth catalyst in the luxury segment.
EBITDA Margin Expansion Visibility
If we look at the revenue breakdown for Alibaba, second-quarter 2019 numbers indicate 15% revenue from sales commissions. I am of the opinion that as Alibaba expands significantly into luxury brands, the sales commission revenue will accelerate.
In general, luxury brands tend to have healthy margins and as sales growth through the Alibaba platform, commissions’ growth will also be robust.
While I don’t expect a meaningful impact in the near-term, healthy commissions can translate into EBITDA margin expansion in the next 3-5 years. This will have a positive impact on free cash flows and valuations.
Therefore, the impact of luxury brands is beyond gross merchandise volume growth or top-line growth.
Final Words on Alibaba Stock
I am surprised by the fact that Alibaba stock has remained largely sideways in the last few quarters. The company has reported strong fundamental developments and the business outlook also remains optimistic.
One reason that can explain the sideways movement is the trade war between China and the United States. However, I expect both countries to work towards a gradual truce and BABA stock can surge higher on further positive developments.
The positive is that investors have a golden opportunity to accumulate a stock that has multiple growth triggers. Over the next 3-5 years, cloud computing, AI chips, Freshippo business, Lazada and luxury brand sales will dictate the stock price trend.
Overall, the outlook for all these sub-segments of business is promising and Alibaba stock is worth accumulating and holding.
As of this writing, Faisal Humayun did not hold a position in any of the aforementioned securities.