Alibaba (BABA) released second-quarter earnings early Tuesday, and everything seemed good on the surface. The company reported earnings of 57 cents per share on a 32% rise in revenue to $3.49 billion.
Analysts had forecast earnings of 54 cents per share and $3.35 billion in revenue, so BABA beat estimates on both counts. After getting a look at the Alibaba earnings numbers, Henry Guo of Summit Research raised his target from $81 to $92, saying:
“Our price target of $92 represents a P/E multiple of 30x our F2017 non-GAAP EPS estimate of $3.08. While Alibaba is valued at a premium to other leading eCommerce players in the world, considering the company’s high top-line growth (revenue up 45% in F2015), strong margin profile and promising profitability perspective (53.5% EBITDA margin in F2015), and massive scale (revenue of $12.3B in F2015), we believe the premium multiple is warranted.”
A few things stick out to me in the Summit Research upgrade, notably the premium 30 P/E multiple using non-GAAP earnings on a company with already massive scale. Maybe I am a little too conservative, but mega-cap companies trading at rich multiples based on somewhat squishy accounting (and Chinese-based to boot) give me pause for concern.
Even foregoing those concerns, the $92 price target for 2017 only implies a roughly 6% annualized return, not exactly a ringing endorsement to buy aggressively at current levels.
BABA Stock Charts
Technically, BABA stock put in a reversal day following the earnings release. It traded up to $85.22 in the pre-market, then opened at the $82.50 level before closing near the lows of the day at $79.44. This price action usually indicates an exhaustion in the rally.
On an intermediate-term basis, BABA stock is getting overbought after rallying nearly 40% in the past three weeks off the Sep 29 low of $57.20. The 14-day RSI is over 70 for only the third time since the IPO in Sep 2014. The previous two instances when the 14-day RSI exceeded 70 marked significant tops in the price of BABA stock.
BABA is also approaching resistance at the $85 level, which was a gap from the last earnings announcement and also marked the most recent high on July 24.
From my perspective, shares of BABA appear to be entering a period of consolidation, given the overbought condition on a technical level and rich valuation following the intensity of the recent rally. It was only Oct 1 that I appeared on BNN-TV, liking BABA stock at the $59 level. With the stock now trading nearly 35% higher at $79, I am definitely less bullish, because price does matter.
I’ve positioned myself to profit from the expected stall out in BABA by selling a November out-of-the money call spread, structuring the short strike right at the $85 resistance level, while defining my risk by buying the $88 call.
In particular, my trade is selling the Nov $85 call and buying the Nov $88 call for 50 cents net credit.
The maximum gain is the 50-cent credit received, while the maximum loss is $2.50. The return on risk is 20%, with the short $85 strike price $5.56, or 7%, above the current BABA stock price of $79.44. I would look to close the position on a meaningful move through the $85 resistance level, or conversely have the spread expire worthless and keep the initial 50 cent credit.
As of publication, Tim Biggam had no position in the aforementioned securities.
