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The Chinese Government’s Grip on Alibaba Is Tightening

How bad has it gotten for Alibaba (NYSE:BABA)? If you bought BABA stock 24 months ago, you’d be losing money on that bet. By comparison, the same bet on the S&P 500 is up 51% over the same period. 

Zombies and Bears Beware, Alibaba Stock Will Still Defeat You!
Source: Shutterstock

If you’ve owned Alibaba’s stock for the entire 24 months, I feel your pain. I wish I could tell you that it’s all going to be all right, but I can’t. At least not until the Chinese government releases Alibaba and other large Chinese internet and e-commerce companies from its vice-like regulatory grip. 

Beijing seems hellbent on bringing fairness to the marketplace regardless of how much these companies’ shares lose in the meantime. Since February, the components of the Nasdaq Golden Dragon China Index, which tracks the performance of 98 U.S.-listed Chinese companies, have seen $920 billion in market capitalization swept away by the government crackdown. 

Widening to sectors other than tech, I’m doubtful the Chinese government will stand down from its position. 

If it doesn’t, you can expect BABA stock to be trading much lower than $171, where it trades at this writing. So, the question to ask yourself is whether or not it’s worth hanging on to your shares. 

I’ll consider the possibilities.

It Might Be Time to Part With BABA Stock

Alibaba hit its all-time high of $319.32 in October 2020. If you were one of the unfortunate people to have bought at this level, I sincerely hope you bought the shares in a taxable account because if it falls much further, you might want to take advantage of the capital gains loss to offset against future gains you might have from your other portfolio holdings. 

However, if you hold the shares in a tax-advantaged account unless you absolutely feel Alibaba won’t recover from its current downturn, you’ll want to ride it out despite the fact Alibaba’s business is getting hit on several fronts. If you can’t hold on, the capital loss won’t be useful to you come tax time. 

So, what’s ailing Alibaba, other than the ongoing government crackdown?

AllianceBernstein analysts issued a report on Aug. 13 about the four major players in the cloud: Microsoft (NASDAQ:MSFT), Alphabet’s (NASDAQ:GOOG, NASDAQ:GOOGL) Google, Amazon (NASDAQ:AMZN), and Alibaba.

While the research firm has a Market Perform rating on BABA stock and a target price of $230 – 40% upside over the next 12 months – its statement about the company didn’t seem nearly as positive. 

“Alibaba’s shares have remained under pressure in recent months, weighed down by regulatory uncertainty in the China Internet sector, but also declining core e-commerce margins, and weaker cloud growth,” the analysts wrote. 

“Looking ahead, we expect the implosion of the education sector to also represent a headwind for cloud growth in China – and for Alibaba. We remain lukewarm on the outlook for Alibaba’s shares – stabilisation in core e-commerce profitability remains the key to better share price performance in our view.”

What About Core E-Commerce Profitability?

Alibaba reported its first-quarter results ended June 30. Revenue growth was healthy, up 34% over last year’s first quarter, to $31.9 billion. If you exclude the integration of its Sun Art acquisition, sales increased by 22% from last year. Meanwhile, its operating income fell 11% year over year to $4.8 billion. 

Looking more closely at its June financials, you’ll see that Alibaba’s operating margins 800 basis points to 15%. Its Commerce segment had an adjusted EBITDA (earnings before interest, taxes, depreciation and amortization) margin of 25%, 1,300 basis points less than a year earlier. 

The lower margin was primarily because of the integration of Sun Art, a big box operator with lower margins. Further, it said in its earnings press release that it expects adjusted EBITDA margins to remain under pressure as the company continues to invest in its growth initiatives.

Are you starting to see where the AllianceBernstein analysts are coming from?

In addition to lower margins in its core e-commerce business, the AllianceBernstein analysts pointed out in their report that Alibaba’s cloud margins won’t be nearly as high as MSFT, GOOGL, and AMZN, because the margins in the U.S. are much higher than in China. That’s primarily a difference in the maturity of each country’s cloud industry.  

The Bad News Won’t Last Forever 

The cloud margins won’t stay down forever, so I wouldn’t worry about that part of its business dragging down its share price. However, you do have to wonder about Alibaba’s e-commerce dominance coming to an end as a result of the regulatory crackdown by the Chinese government. 

When Alibaba reported its results in early August, not only were they lower than analyst expectations – the consensus for its core revenue was $28.5 billion and it came in at $27.9 billion, $600-million shy – but it lost market share to some of its smaller competitors including JD.com (NASDAQ:JD).

The South China Morning Post recently discussed the State Administration for Market Regulation’s (SAMR) move to draft new rules to curb “inappropriate activities in cyberspace.” 

Alibaba has already said it will respect any new rules from SAMR. I believe them. It might want to be a global player, but China is still its golden egg. It does not want to kill that. 

The reality is that Alibaba still generated $3.2 billion in free cash flow in the first quarter. Over the trailing 12 months, its FCF was $26.5 billion. Based on a market cap of $433.0 billion, it has an FCF yield of 6.1%. I consider anything above 8% to be value territory.

That said, against its five-year average for virtually every major valuation metric, BABA stock is cheaper than it’s been since it went public in September 2014. 

While the Chinese government’s grip on Alibaba and others is tightening, I suspect that the two parties will figure out how both can win over the long haul. 

At $171, BABA stock is growth at a reasonable price. That said, if you do buy, don’t expect it to be a volatility-free ride to profits. Be ready to buy on further corrections. 

On the date of publication, Will Ashworth did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

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.


Article printed from InvestorPlace Media, https://investorplace.com/2021/08/the-beijings-grip-on-baba-stock-is-tightening/.

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