As compared to the broad market, Alibaba (NYSE:BABA) stock has been relatively subdued through fiscal year 2020. BABA stock has trended higher by 23% during this period.
JD.com (NASDAQ:JD), which is a close peer, has out-performed, having surged by 132% for the same period. I believe that at a forward price-to-earnings-ratio of 25.3, BABA stock is an attractive long-term investment. At the same time, investors with a short-term horizon can trade BABA stock for potential upside in the next few months.
Before I discuss the upside triggers, it’s worth mentioning that BABA stock touched a high of $317 in October 2020. However, with China suspending Ant Group’s initial public offering, BABA stock slipped.
I will not be surprised if the stock re-visits the highs in the next few months.
Near-Term Bullish Triggers for BABA Stock
I believe that the fourth quarter results for 2020 will be the first positive trigger for the stock. The holiday season sales are likely to be robust.
In November, the company’s Global Shopping Festival generated $74.1 billion in sales. Sales were higher by 26% as compared to the prior year period. Strong top-line growth in the quarter is likely to boost stock sentiment.
Another near-term trigger for the stock is the cloud business performance. For Q3 2020, the cloud segment revenue growth was 60% on a year-on-year basis.
Importantly, adjusted EBITDA losses narrowed to $23 million. The segment is likely to be profitable for the first time when Q4 2020 results are reported. This is likely to take BABA stock higher.
Recently, Ant Group came out in support of regulations with Chairman Eric Jing commenting that the company was “working closely with regulators and doing its best to deal with the aftermath of the listing suspension.” Alibaba was also fined by regulators under the anti-monopoly laws.
It seems to me that the worst is over from a regulatory headwind perspective. This is another reason to be bullish in the near-term.
BABA Stock Is a Value Creator
Before talking about Alibaba’s long-term growth drivers, I want to mention an important point about Amazon (NASDAQ:AMZN). For Q3 2020, Amazon derived 12% of its revenue from Amazon Web Services.
For the same period, 57% of operating income was from AWS. Clearly, the cloud business has turned out to be a major profitability and cash flow driver.
I earlier mentioned that Alibaba is likely to be profitable at EBITDA levels in Q4 2020. The company has planned to invest $28 billion in the cloud business over the next three years. The cloud segment will be another cash flow machine for Alibaba in the coming years.
In the e-commerce business, I expect healthy growth to sustain. Southeast Asia is another big e-commerce market and Lazada is a market leader in the region. The company already has 65 million users across six countries.
Within China, the growth of luxury retail is another positive trigger for Alibaba. Even after the impact of the pandemic, China has doubled its overall share of the global luxury market in FY2020. I am therefore bullish on Tmall (Alibaba’s e-commerce site) and as luxury product sales increase, there is likely to be a positive impact on the EBITDA margin.
From a financial perspective, Alibaba reported free cash flow of $5.9 billion as of Q3 2020. This implies an annualized FCF of over $22 billion. The company therefore has ample financial headroom to invest in innovation driven growth and inorganic growth.
Concluding Thoughts
Analyst estimates indicate that Alibaba’s annual earnings growth is likely at 20.2% for the next five years. A P/E of 25.3 is therefore attractive considering the growth outlook.
From a long-term perspective, I also believe that Alibaba can initiate dividends at some point of time. The company has robust FCF even if we incorporate the investments. Further, as the cloud business generates cash, there is ample scope for FCF upside in the next few years.
Overall, BABA stock might have bottomed out at around $250. In the next few months, I will not be surprised if the stock trades above $300.
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.
Faisal Humayun is a senior research analyst with 12 years of industry experience in the field of credit research, equity research and financial modelling. Faisal has authored over 1,500 stock specific articles with focus on the technology, energy and commodities sector.
