Alibaba (NYSE:BABA) Chief Financial Officer Maggie Wu said on Sept. 30 that the company’s cloud business would become profitable in its current fiscal year that ends on March 31, 2021. For those who own BABA stock, that’s excellent news.
For investors who don’t own Alibaba stock, the news ought to make them consider getting on board, even though the shares are already up 37% this year.
Here’s why.
It’s Early in the Cloud Game
In March 2017, I was already focusing on Alibaba’s cloud business as an important part of the e-commerce company’s growth plans. I couldn’t help but notice how much profit Amazon’s (NASDAQ:AMZN) cloud business was generating at the time.
“Amazon entered the cloud computing business in 2006. Amazon Web Services (AWS) now generates more than $3.1 billion in operating income (fiscal 2016) from $12.2 billion in revenue, a juicy operating margin of 25.4%,” I wrote in March 2017.
“This was considerably higher than the $1.1 billion {of operating income} it generated from $123.8 billion…. in revenue from its e-commerce and Amazon Prime membership fees.”
Fast forward to fiscal 2019. Amazon Web Services, better known as AWS, reported operating income of $9.2 billion on $35.1 billion of revenue, an operating margin of 26.2%.
More importantly, AWS contributed 63% of Amazon’s overall operating profit of $14.5 billion in 2o19. You’d have to be blind (no offense meant to those who are) not to see the effect that Amazon’s cloud business has had on both the company and its share price.
Perhaps that’s why Alibaba CEO Daniel Zhang said in 2018 that the company’s own cloud ambitions would be a significant growth driver.
Its Cloud Business Is Accelerating
“We strongly believe that every business in the future will be powered by [the] cloud. We are very happy to build this cloud infrastructure in a new digital era and support all business,” Zhang told CNBC in a November 2018 interview.
In fiscal 2018, Alibaba’s cloud business generated revenue of 13.4 billion yuan ($2.14 billion) and adjusted EBITA of -799.0 million yuan (-$159.5 million). In fiscal 2020, the unit’s revenue came in at 40.0 billion yuan ($5.65 billion) and adjusted EBITA of -1.4 billion yuan (-$197.7 million).
“In a speech on Wednesday, Zhang called the technology a ‘growth engine’ but said the world is in a ‘nascent stage of the global cloud era,’” CNBC reported on Sept. 29.
“The Alibaba CEO said cloud computing is ‘the kind of opportunity that comes only once in a generation.’”
Despite the increased competition that Alibaba’s cloud unit has faced over the past several years, it’s impossible not to see its potential. In the first quarter of fiscal 2021, Alibaba’s cloud revenue grew almost 59% year-over-year.
It’s not surprising, then, that Alibaba will spend $28 billion over the next three years on its cloud business. I don’t think there’s any question that it will be money well-spent.
Is the Next Stop for BABA Stock $400?
In January 2018, I wondered what it would take for BABA stock to get to $400.
Based on how fast it moved from $100 to $200, I predicted that it would double once more by June 2019. It’s managed to appreciate by 41% in the 32 months since January 2018; that’s a good, but not a great, return.
Now that Alibaba believes its cloud segment will be profitable by March, while its Cainiao logistics business ought to become cash-flow positive by the end of 2021, investors will likely be gobbling up its stock in the next 12 months.
In the 12 months that ended in June, Alibaba’s free cash flow was 150.7 billion yuan ($21.3 billion). Based on an enterprise value of $741.21, it has a free-cash flow yield of 2.9%.
Historically, value investors often look for FCF yields that are 8% or higher. From this perspective, BABA stock doesn’t seem too cheap at the moment. However, it’s actually right in-line with its five-year average price-cash-flow ratio .
Meanwhile, its operating cash flow continues to grow by 20% annually. That suggests that a couple of years from now, after its cloud unit grows tremendously, the company’s current 2.9% free-cash flow yield is going to seem awfully cheap.
I believe that Alibaba is the best Chinese stock for long-term investors.
On the date of publication, Will Ashworth did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia. At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.
