Alibaba (BABA), in my view one of the best long-term plays to benefit from China's rise, is no longer trading at its firesale prices from Christmas Eve 2018, yet still far away from its all-time high.
Optimism surrounding U.S.-China trade talks helped the stock's large rebound. The company's latest quarterly earnings, despite showing decelerating growth, have been much better than expected and are a testament to the strength of Alibaba's underlying business.
Source: China Daily
The stock could remain highly volatile depending on whatever news reaches us from the tariff sphere. For long-term investors, though, with patience, none of that should really matter, and while new investors have missed the Christmas bottom in the stock, the stock remains attractively priced.
What is going on at Alibaba?
The headline figures of Alibaba's latest earnings release reveal a mixed picture. While it easily beat on EPS, it missed revenue estimates by $380M as its growth rate decelerated to 41% from 54% sequentially. This holiday quarter, despite being the biggest ever, was largely impacted by a softer Singles' Day and tariff-related headwinds; however, 41% Y/Y growth for a $433B market cap stock is nothing to be ashamed of.
Source: Alibaba Investor Relations
While the previous quarter already showed a slight deceleration in growth, down from 67.8% to 54%, another 13pp sequential drop seems harsh. None of that though impacts the long-term investment case.
By division it recorded 40% Y/Y growth for Core Commerce, by far the largest segment, 84% for Cloud computing, 20% for Digital media and entertainment and 73% for Innovation initiatives.
Cloud Computing clocked in another very strong quarter and its growth rates are roughly in line with the performance of Microsoft's (MSFT) Azure cash cow. Importantly, the trade war does not seem to have affected spending of enterprise customers as Alibaba remained very productive, launching a whopping 678 new products and features for Alibaba Cloud. The Cloud Computing segment, despite still small compared to Core Commerce, has increased its share by 2pp in 2018 to 6% of total revenue, slightly lowering the dependence on Core Commerce.
The stock reacted positively to this and has strongly rebounded from its recent lows but certainly remains very jittery as the tariff uncertainty continues.
It seems that logical reasoning has returned with investors focusing on fundamentals rather than some obscure threats related to the trade war. I am very confident that an agreement can be reached, but in case it won't, I will happily embrace buying this stock at lower prices.
Alibaba's management itself shared a very interesting perspective in the context of the Chinese economy:
The size of the Chinese economy is US$13 Trillion. In the future, obsessing on the rate of growth is not meaningful, because of the law of large numbers. The reality is the absolute dollar amount of new wealth creation in the Chinese economy will be well over US$800 billion each year.
We have conviction that e-commerce and digitization of retail will continue to grow at a faster rate than the overall economy. While the overall economy grew in single digits, e-commerce sector GMV grew at 20% to 30% over the last several years.
In my view, the Chinese e-commerce market is the best secular growth market for a company to be operating in. Alibaba itself thinks that the law of large numbers paired with high growth rates needs no further arguments for long-term investors.
Alibaba's core market - the Chinese e-commerce market - is forecast to almost double by 2022, reaching a size of $1.8T, according to a report, "E-commerce in China: Trends and Outlook for the Largest e-commerce Market in the world," by research firm Forrester. To put that into perspective, this means that the Chinese online retail market will be more than double the size of the US market three years from now.
In the U.S., online retail giant Amazon (AMZN) holds a commanding market share of almost 50% and, despite the recent drop, boasts a market cap of $860B, more than double Alibaba's current market cap of $420B.
It is hard to fathom the enormous size of the Chinese online retail market. But given that China's population is more than 4 times larger than that of the U.S., with a GDP of roughly 60% of the U.S., an online market double the size of the U.S. does not seem unrealistic. If we now consider that Amazon with a slightly worse market share than Alibaba, in a market roughly half that of the Chinese market, is boasting a market cap more than twice as large, we can easily see that there is a significant valuation mismatch between these two giants.
The trade war itself, although it has pushed down growth rates in Core Commerce, is more sentiment than reality as generally most of Alibaba's business is dependent on domestic consumption as opposed to foreign exports. Certainly, if consumers get scared by further tariffs and deteriorating trade relations, a slowdown in the Chinese economy will eventually also hit Alibaba significantly, but that basically applies to every company. Alibaba has over 700 million customers, and even if they temporarily spend less, they won't go away as Alibaba has created quite a sticky ecosystem for Chinese consumers shopping on Taobao and Tmall.
Similar to Facebook (FB) where investors are eagerly eyeing active users, the same can be said for Alibaba, but there the focus is mainly on Monthly Active Users and Annual Active Consumers.
Alibaba has now reached 700 million mobile monthly active users (MAUs) and 636 annual active customers (AAC). These figures alone are impressive, but what excites me even more is that the sequential growth rates have remained very strong and show no signs of a slowdown. Although Alibaba is generating healthy profits, it is still in a strong double-digit growth era where it invests heavily into its business and technologies, and thus the best metric to assess these endeavors is basically user growth. Quarter after quarter like a Swiss clockwork Alibaba is setting new record highs for its user base.
To ensure Alibaba continues its strong user growth, the company is rolling out new initiatives and technologies. During the December quarter, it launched a new mobile interface and has already seen effective user engagement and improved profit operating efficiencies in mobile product.
And although most of Alibaba's sales, profits, consumers and growth comes from China, it has started to globalize its business starting in Southeast Asia which is the fourth largest region by GDP and in close proximity to Alibaba's China operations. Alibaba's is operating in that area via wholly-owned Lazada Group. This is another large and growing market for Alibaba to benefit from, and by leveraging its tested technology, supply-chain know-how and local market knowledge, success seems to be the only outcome.
Alibaba has years and potentially decades of double-digit growth ahead as the current and future size of China's economy alone and the emergence of a giant and affluent middle-class will provide more than enough fuel.
Short-term hiccups with growth decelerating and uncertainty surrounding the state of the Chinese economy and potential further tariffs only create attractive buying opportunities and are no reason to sell the stock unless you feel you are able to properly time the market. I certainly don't feel that way and instead only focus on the fundamentals and perspectives, as in the long run this will be reflected in the stock price as well.
On top of that, Alibaba is still rather small compared to Amazon, but is growing much faster and in prime position in the world's largest economy in the future.
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Disclosure: I am/we are long BABA, AMZN, MSFT, JD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I am not offering financial advice but only my personal opinion. Investors may take further aspects and their own due diligence into consideration before making a decision.