Alibaba (NYSE:BABA) stock seems to have completely capitulated. At a time when broader markets have shown strength, BABA stock is down by 42% in the last 12-months. For a high-growth company, this downside is significant.
The reason for sustained selling is also no secret. Alibaba has been a prime target of regulatory headwinds.
This holds true for other Chinese stocks as well. However, it seems to me that the sentiment is over-bearish.
Marshall Wace, one of the world’s largest hedge funds, believes that Chinese ADRs are now not investable. This is the extent of bearish sentiment. I would not blame investors. Chinese regulatory authorities have indeed created an uncertain environment.
Let me talk a bit about macroeconomics here. In general, the government sector is the static sector of the economy. The role of the government is to create conducive policies for the private and household sector to flourish. It’s the private sector that’s the dynamic or growth-triggering sector of the economy.
Too many regulations would eventually translate into lower GDP growth. I am sure that the Chinese authorities are aware of this basic economic fact. It seems very likely that companies will iron out differences with regulators in the coming months.
Once the dust settles, Chinese stocks are likely to witness a sharp rally. I would not go overweight on any Chinese stock, but some exposure to BABA stock can be considered at current levels.
BABA Stock and the Regulators
It’s worth noting that Alibaba is not fighting against Chinese regulatory authorities. The company has been in a mode of accepting the allegations and taking corrective measures.
In April 2021, Alibaba was fined $2.8 billion after the monopoly probe. The company has accepted the punishment and promised corrective measures.
In another recent news, Alibaba has pledged to spend an equivalent of $15.5 billion towards fostering common prosperity. Social equality is on the agenda of the Chinese government and several companies have already pledged to be a part of this initiative. Again, it’s an effort to mend broken ties with the authorities and regulators.
Another piece of big news is that state-backed firms are likely to take a sizable stake in Ant Group. It goes without saying that Alibaba Group will lose grip on the fin-tech giant. However, reports suggest that it might revive the initial public offering.
Clearly, there are efforts to iron out differences and get the focus back to the core business. This seems likely in the coming months and BABA stock might have bottomed out.
Revenue and Cash Flow Upside Are Robust
Even with the regulatory challenges, Alibaba has continued to deliver robust numbers. For the first quarter of 2021, the company reported revenue growth of 34% to $31.9 billion.
For the core commerce segment, year-on-year revenue growth was 35%. It’s worth noting that international retail commerce growth was 54%. It’s likely that Southeast Asia will be a key growth driver in the coming years. Additionally, the core commerce segment remains the cash cow.
Cloud computing revenue was higher by 29% on a year-over-year basis to $2.5 billion. The cloud segment has delivered positive EBITDA for two consecutive quarters.
It seems very likely that EBITDA margin will expand in the next few years. As the cloud computing business gets bigger, Alibaba will have another source of significant free cash flow.
An important point to note is that Alibaba ended Q1 2021 with cash and equivalents of $72.9 billion. Further, for the quarter, the company reported free cash flow of $3.2 billion. Clearly, the company has robust financial flexibility. This is likely to be deployed in innovation-driven organic growth and acquisitions.
Therefore, the outlook for the company’s business remains bright. Once regulatory headwinds wane, BABA stock is likely to trend higher.
Overall, the dominant sentiment for BABA stock is fear. I agree that there is a significant amount of risk in investing in an uncertain regulatory environment.
However, a small exposure to Alibaba can be considered at current levels. A sharp reversal might be on the cards if issues are sorted out on the regulatory front.
On the date of publication, Faisal Humayun did not have (either directly or indirectly) any positions in any of the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Faisal Humayun is a senior research analyst with 12 years of industry experience in the field of credit research, equity research and financial modeling. Faisal has authored over 1,500 stock specific articles with focus on the technology, energy and commodities sector.