The China internet growth story has come on full force, and at the front of the trend is Alibaba Group Holding Ltd (NYSE:BABA). To understand just how big this trend is, look no further than BABA stock, which has already doubled in 2017.
Often dubbed the Amazon.com, Inc. (NASDAQ:AMZN) of China, Alibaba controls the China digital commerce market and is aggressively expanding its commerce business into new geographies. The company is also a serious and growing competitor in the global public cloud market. BABA stock is making forays into the internet-gaming world, building out its brick-and-mortar retail presence and slowly gaining more control of the largest logistics market in the world. Plus, the company is at the forefront of artificial intelligence research.
Put it all together, and it’s no wonder that BABA stock has doubled so far this year.
But is this run over? Or is there more gas in the tank?
I think the latter. Alibaba stock remains dramatically undervalued considering the company’s robust growth potential.
Alibaba Stock Is on Fire
There are no “ifs,” “ands” or “buts” about it. Alibaba’s business is on fire.
Obviously, the core retail business is benefiting from secular growth in digital commerce. The runway for growth here is very clear. As China’s consumer landscape starts to look more and more like America’s, the more Alibaba’s retail business will benefit from the emergence of digital shopping. The runway for growth will also be extended by Alibaba expanding into new geographies which are largely untapped on the digital commerce front (see Southeast Asia).
It is also worth noting here that Amazon, the company seemingly hell-bent on world domination, appears to be throwing in the towel when it comes to competing with Alibaba in China. Amazon recently ran a giant Kindle promotion across Alibaba’s shopping sites, a sign that Amazon is giving up on trying to compete in the China e-commerce market. All signs point to Amazon turning its attention to India.
Beyond retail, Alibaba’s cloud business is growing with exceptional pace. Cloud computing revenue nearly doubled last quarter, and it looks like that momentum has remained strong so far this quarter. Semiconductor company STMicroelectronics NV (ADR) (NYSE:STM) recently announced a partnership with Alibaba Cloud to create the first Chinese cloud-to-node Internet of Things (IoT) platform. Moreover, Alibaba Cloud also recently announced a partnership with Red Hat Inc (NYSE:RHT).
Alibaba only holds 2.6% market share in the global cloud infrastructure services market, but Alibaba Cloud is the fastest-growing major cloud platform. Partnerships like the ones mentioned above will help Alibaba keep this title.
Then there is the whole “other bets” part of Alibaba’s business, which includes tapping into China’s $11.8 billion and rapidly growing online gaming market, attempting to seize more control of China’s massive logistics market, and opening up IKEA-like stores in an attempt to capture the non-digital shopper.
Alibaba Stock Could Head to $235
All in all, the Alibaba growth story is on fire. Yet, Alibaba stock remains notably undervalued.
BABA stock trades at 36 times fiscal 2017 earnings estimates of $4.87 per share. Earnings are expected to grow about 30% per year from the $4.87 base to $8.31 in fiscal 2019. That 30% growth rate seems very reasonable considering the catalysts which drove nearly 100% profit growth last quarter (commerce build-out, cloud ramp, and AI initiatives) will remain in play into the foreseeable future.
A 36-times multiple for 30% growth is pretty good bang for your buck. That is a price-to-earnings/growth (PEG) ratio of about 1.2. The S&P 500, meanwhile, is trading at 19.6 times 2017 earnings for roughly 10.7% annual growth expectations into 2019. That is a PEG ratio of about 1.8.
So long as BABA features a significantly more attractive PEG profile than the broader market, then Alibaba stock remains undervalued.
As far as the price target is concerned, I think Alibaba stock will trend toward $235 over the next 12 months. From a fiscal 2018 earnings base of about $6.50, I think multiyear growth potential will look more like 20% (versus 30% from fiscal 2017). If you apply a market PEG of 1.8 to that 20% growth, you get a “fair” P/E multiple of about 36. A 36-times multiple on $6.50 fiscal 2018 earnings implies a one-year price target of just under $235.
Bottom Line on BABA Stock
The growth story is on fire, and BABA stock is undervalued. That means buy now and hold until the valuation appropriately reflects the company’s robust growth potential.
As of this writing, Luke Lango was long BABA and AMZN.
