Many people are concerned about the Chinese coronavirus outbreak and the steps the government is taking to contain it. And obviously, Alibaba (NYSE:BABA), the Chinese e-commerce giant, is directly affected. BABA stock has already fallen 9% from its peak as a result.
BABA stock has a $558 billion market value, and this drop represents a hit of over $50 billion. The company is likely to be hit pretty hard during its first quarter.
Since the virus outbreak became big news, the expected effect on Alibaba began to take over investors’ fears.
Rising Sales and FCF Pushed Up Alibaba
Up until then, BABA’s earnings and free cash flow (FCF) were rising dramatically.
For the last 12 months (LTM), quarterly FCF growth had been slowing. That is, up until recently. The chart I have prepared below shows that in the past several quarters, Alibaba was moving forward.
In the last two calendar quarters of 2019, growth was in the high teens (including my estimate of its fourth-quarter numbers).
This chart shows how powerful Alibaba’s free cash flow has been.
That growth, however, could be in jeopardy with the huge coronavirus outbreak in China. But will the company really lose $50 billion in profits over the virus outbreak, as the drop in its market value implies?
Not likely. That would represent over three quarters of its FCF generation capability. So that leads me to believe there may be an opportunity here for clear-thinking investors.
How Will The Virus Impact BABA Stock?
That is the question that many want to know right now. It is clear that there will be a pretty severe economic impact in China. The outbreak has brought back memories of the SARS outbreak in 2002 and 2003.
The Financial Times says that Hong Kong went into a recession in 2003. The Hang Seng index fell 7.5% at that time.
Given that BABA stock, worth over a half a trillion dollars in market value, is already off 9%, one might hope this is the worst. So far, the company has not stated how the virus outbreak has affected its business or will affect it.
Being Contrarian About Disasters
The most important thing to remember about disasters is that they end. It turns out that recovery can actually bring a big surge in economic activity.
Part of the reason is pent-up demand. For example, China has locked down many cities. Normal economic activity is stunted. However, online activity with companies like Alibaba is likely to not be suffering as much as traffic to brick and mortar retailers.
It turns also turns out that the Chinese government is likely to take efforts to spur economic growth once the virus starts to slow down. That could also have a beneficial effect on sales for companies like Alibaba.
So, in a contrarian sort of way, it turns out that the best thing for BABA stock is this crisis. The market looks forward and discounts the next six to nine months ahead.
Don’t forget that BABA stock has already fallen from its peak, likely discounting a lot of the bad news that can be expected over that timeframe.
What Should Investors in BABA Stock Do?
No one knows how bad the outbreak will get. One thing you can do is average-cost down in a stock like Alibaba, as the bad news keeps coming out. That way you don’t have to try and time the market.
In the end, you will be better off by using this method. The key is to have faith that the recovery period will eventually come back for the factors affecting a stock negatively.
As of this writing, Mark Hake, CFA does not hold a position in any of the aforementioned securities. Mark Hake runs the Total Yield Value Guide which you can review here. The Guide focuses on high total yield value stocks. Subscribers receive a two-week free trial.
