Alibaba's Strategic Shifts: Cloud Focus, International Expansion, and Margin Improvements

Alibaba: Bullish On Cloud, International Digital Commerce And Margin Expansion, Buy (BABA)

However, I am not too fussed about missing this run up, as I believe it is still early days for a full-fledged turnaround. Hence, I anticipate further chances to accumulate the stock over time. Some renowned investors such as Michael Burry have also become more bullish, as recent 13-F filings show an increased portfolio weight in BABA from 8.74% to 21.26%. And a lack of improvement in operating margins (as discussed later in this article). Now, I too am turning bullish on Alibaba stock as I note the following: There is a clear growth acceleration in Alibaba Cloud's revenues as the TTM YoY growth rates have rebounded to the high-teens level: This growth is driven mostly (more than half) by AI-related products and workloads: ...public cloud revenue [is] maintaining double-digit growth. AI-related product revenues sustained a triple-digit growth continuing to increase its share of public cloud revenue... more than half of that expected growth will be driven by AI products - CEO, Head of Core E-Commerce Yongming Wu in the Q1 FY25 earnings call Leading indicators of growth are also robust, since Alibaba Cloud's customers are having significantly increased budgets for spending this year: What we see certainly among our own cloud customers is that their AI budgets for this year are higher, significantly higher than what they were last year. - CEO, Head of Core E-Commerce Yongming Wu in the Q1 FY25 earnings call The company is also seeing impressive growth in its Alibaba International Digital Commerce (AIDC) business: Here, the growth comps are extremely favorable; Q1 FY25's 44.2% TTM YoY is on the back of an already robust 23.7% TTM YoY in Q1 FY24. A key driver of this growth is increased activity in AliExpress due to improvements in user experience, expanded assortment, product placement and presentation. This is bolstered by optimized logistics in Cainiao that has "significantly reduced average delivery time", which has also been reflected in robust almost 30% TTM YoY growth in that segment: Altogether, I believe the combined 32.5% revenue mix coming from these 3 growth segments - Cloud Intelligence, AIDC and Cainiao - are indicative of some meaningful growth shoots in Alibaba. In my initiating coverage of Alibaba stock, I had identified margin expansion as a key upside risk as the company's unprofitable segments transition toward profitability: But I was dismayed by a lack of progress on this front after Q4 FY24, which has continued this quarter as BABA's adjusted TTM EBITDA margins have been mostly steady at around 17%: However, I am more optimistic about the margin expansion thesis playing out now because management seems to be focusing more explicitly on monetization of the loss-making businesses. Indeed, management has now disclosed a concrete 1-2 years timeline for reaching breakeven. This gives me some comfort and assurance on margin progression: ...we've implemented strategic realignments across our key Internet technology businesses through a thorough evaluation of their product capabilities and market competitiveness while maintaining product competitiveness, most of these businesses will now place a higher priority on monetization... We expect most of these businesses to breakeven within 1 to 2 years and gradually contribute to profitability at scale. - CEO, Head of Core E-Commerce Yongming Wu in the Q1 FY25 earnings call At a 9.4x 1-yr fwd PE, BABA trades at a hefty 62.3% discount to its longer term 1-yr fwd PE of 24.9x, which, I believe, is quite low even after assuming some de-rating effects due to the risks of investing in China. However, it has been at these discounted levels for a while and still, I had not been convinced of a buy. So what is different this time? I am more confident of the catalysts in the form of growth in the 3 businesses aforementioned and the margin expansion of unprofitable business segments. Importantly for incremental thesis validation checks, there is a clear 1-2 year timeline for these catalysts to steadily play out. On a comparable valuation basis vs other Chinese internet peers, Alibaba trades at a small 6.4% premium to the 8.8x median 1-yr fwd PE of the compset: Note that Seeking Alpha's 1-yr fwd PE for Alibaba is a bit higher at 13.32x. Also, the sector median PE is shown to be 17.02x. I suspect these differences to the values I have used are due to: If this is your first time reading a Hunting Alpha article using Technical Analysis, you may want to read this post, which explains how and why I read the charts the way I do. All my charts reflect total shareholder return as they are adjusted for dividends/distributions. On the relative technicals vs the S&P 500 front, I notice that the momentum of the sellers' progress is fading since the size of new lower lows are shrinking. Moreover, the ratio chart seems to be forming a base on the weekly chart. Synthesizing these two observations together, I believe there are higher chances of a move up (corresponding to outperformance) toward the 4-monthly resistance. Alibaba generates 46% of its TTM revenues and 118% of its adjusted TTM EBITDA from Taobao and Tmall Group, which form the China Commerce (domestic online retail arm) of the company. Given Alibaba's scale, I believe the monthly China's Retail Sales data is a useful indicator of future quarterly earnings: So far, the growth track in China's Retail Sales continues to be slow at 2-3%. Hence, it is not much of a surprise that Alibaba's TTM China Commerce Revenue growth is also mostly stagnant at around $430 million for the past 4-5 quarters: I don't believe July 2024's China Retail Sales print of 2.7% is enough to buck the stagnant growth trend in this largest segment for Alibaba. However, I continue to track this macro variable to try to identify growth revival points prior to the official quarterly releases. Despite lackluster revenue growth and no margin improvement, Alibaba stock remains an overwhelming favorite of Wall St and some renowned investors such as Michael Burry, who has increased his total stake in BABA to a portfolio weight of 21%. I have been hesitant to share the same enthusiasm for Alibaba until now: I believe Alibaba Cloud, Alibaba's International Digital Commerce and its Smart Logistics Network, which altogether make up 32.5% of TTM revenues, are all experiencing growth shoots. Management's renewed focus on monetization with a concrete 1-2 year timeline to breakeven on currently unprofitable businesses also reinvigorates my optimism on margin expansion. With these catalysts and favorable relative technicals vs the S&P 500, I find the discounted valuations at a mere 9.6x 1-yr fwd PE attractive. One key monitorable I'm tracking is China's Retail Sales figures, as that would provide useful clues on a rebound in Alibaba's most material (46% of TTM revenues and 118% of TTM adjusted EBITDA) albeit stagnant segment of China Commerce. Rating: 'Buy' Strong Buy: Expect the company to outperform the S&P 500 on a total shareholder return basis, with higher than usual confidence. I also have a net long position in the security in my personal portfolio. Buy: Expect the company to outperform the S&P 500 on a total shareholder return basis Neutral/hold: Expect the company to perform in-line with the S&P 500 on a total shareholder return basis Sell: Expect the company to underperform the S&P 500 on a total shareholder return basis Strong Sell: Expect the company to underperform the S&P 500 on a total shareholder return basis, with higher than usual confidence The typical time-horizon for my views is multiple quarters to around a year. It is not set in stone. However, I will share updates on my changes in stance in a pinned comment to this article and may also publish a new article discussing the reasons for the change in view.

Alibaba's Reversal Keeps Going (NYSE:BABA)

Looking for a helping hand in the market? Members of Beyond the Wall Investing get exclusive ideas and guidance to navigate any climate. Learn More " If you read my articles regularly, you probably know that I'm very skeptical about buying shares in Chinese companies in the long term - I'm particularly put off by the well-known VIE structure and the authoritarianism of the CCP that's limiting China's growth prospects, in my view. It was the combination of these factors that didn't allow me to upgrade Alibaba Group (NYSE:BABA) (OTCPK:BABAF) stock back in February 2024 when information about the purchase of the stock by co-founders Jack Ma and Joe Tsai appeared on the market. However, the sentiment in my subsequent articles became more positive, even if my rating remained neutral and did not change to "Buy". In my last article at the beginning of May 2024, I pointed out that the BABA stock had the potential to initiate a significant turnaround in the short to medium term due to several factors. Since then, the stock has risen by around 4.5%, still lagging behind the broader strength of the US market. As of today, I still believe that the stock has substantial potential to continue its reversal, which, I think, has already begun. This is particularly true when considering the short to medium-term period. In the longer term, I remain skeptical about Chinese assets, primarily due to the unique characteristics of the Chinese economy and its political system. Before diving into an analysis of Alibaba, let's take a top-down approach. We'll begin with the macro landscape and the Chinese stock market as a whole, and then gradually focus on the company itself. First of all, let me clarify why I generally dislike Chinese assets as instruments for long-term investment (relative to Western assets). In many ways, I don't like the political landscape there. Can you imagine an authoritarian-type country where the stock market, adjusted for inflation and local currency devaluation, grows similarly to developed markets (if we take the last decade)? In recent years, it has become common to berate the democratic system for its various shortcomings. However, in my opinion, it is the democratic system that allows the economy to adapt very quickly to a rapidly changing reality. Authoritarian systems, on the other hand, are very closely tied to the once-entrenched opinions of the elite, which naturally become less flexible with age. Over time, such systems run the risk of making irrational decisions in a crisis. Apparently, this is exactly what we are seeing in China today. As Bob Elliot recently pointed out in his X's thread, China's current economic policies may be flawed in several ways. First of all, the Chinese government seeks to minimize risk in the financial system by tightly controlling various economic activities, including a crackdown on the financial sector, fiscal austerity, restrictions on speculation in government bonds, and restrictions on institutions selling shares. While these measures are intended to stabilize the economy, they are often at odds with basic economic and market principles. Secondly, the CCP's policies seem to be disrupting the natural functioning of markets. What is meant here is that by tightly controlling key economic indicators like bond yields, exchange rates, and stock prices through "corridor management," the government is effectively imposing a planned economy mindset. So this approach reduces market volatility and participation, which can lead to lower liquidity and a dysfunctional capital market. The restrictive policies are causing economic agents - such as businesses and investors - to lose confidence and reduce their participation in the economy. So this lack of engagement further diminishes market activity and may hinder real economic growth going forward. Thirdly, Bob Elliott warns that the continued application of these stringent controls could lead to a critical point where the system breaks down, similar to how China's zero-COVID policies were eventually abandoned after causing significant social and economic strain. Before this tipping point is reached, the economy may continue to suffer under these restrictive policies. This is why I am still wary of investing in China in the long term. However, none of this changes the fact that there may be some interesting opportunities to participate in individual recovery rallies in the medium to short term. I think something similar has formed in Chinese stocks today. First off, Chinese assets have become quite cheap compared to their historical valuations, even in recent years. The discount relative to developed markets is currently ~50% according to FactSet data [proprietary source], which is near a historical maximum. At the same time, according to Goldman Sachs [proprietary source], the current 12m price-to-earnings ratio indicates a significant undervaluation of the entire market. Secondly, this undervaluation is supported by conclusions about tactical "oversoldness" based on quantitative models. For instance, analysts from BCA [proprietary source] recently expressed the following opinion: Through the past few years, Chinese equities have gone nowhere. Nevertheless, they have offered excellent tactical long and short opportunities, from short-lived uptrends and downtrends reliably bookended by collapses in 65-day price complexity. Following a sharp sell-off since May and a continuation of the tactical pattern, the latest collapse in short-term price complexity offers a good tactical entry point for an outright long or for an overweight Hedge fund positioning has fallen to very low local levels, and BofA's risk models [proprietary source] suggest that general market sentiment has entered panic territory. So if we are going to catch a "local bottom", it is probably now. One of the few stories that can play out this idea of recovery, in my opinion, is Alibaba stock. Driven by its "strategic focus on user-centricity and AI integration", Alibaba demonstrated quite solid performance for its fiscal Q1 FY2025 [reported on August 15, 2024]. Q1 revenue of ~$33.5 billion was an increase of ~4% YoY, while EBIT of almost $5 billion (-15% YoY) led to a better margin (18% vs. 15% last year). The company recognized increased impairments on some of its investments, so the YoY decline in absolute EBIT led to lower net income and EPS. However, if we examine individual segments, I think we can see that Alibaba has the potential to show improvement in the coming quarters, despite the overall weakness of the Chinese economy. For instance, Taobao and Tmall Group (TTG) experienced solid growth in both GMV and order volume (by high-single-digit and double-digit year over year, respectively), aided by "increased purchase frequency and improved market share dynamics." I believe the introduction of new marketing tools like Quanzhantui should further align CMR growth with GMV trends, positioning TTG for sustainable future gains. On the other hand, Alibaba Cloud saw a return to positive growth (+6% YoY on a consolidated basis), particularly in public cloud services and AI products as the company reported double-digit growth in public cloud revenue and triple-digit growth in AI-related products, driven by "increasing customer adoption of Alibaba's AI capabilities." Another very important revenue source - Alibaba International Digital Commerce (AIDC) - reported a robust 32% YoY revenue growth, largely "fueled by cross-border businesses like AliExpress, which saw continued order growth and improved logistics efficiency." According to the management's commentary, the firm is also expanding its footprint in key markets such as Europe, Turkey, and Southeast Asia, with Lazada achieving EBITDA profitability for the 1st time, which is a good thing. That is why, based on the recent dynamics of the company's individual segments, it seems to me that the business as a whole is improving - the prospects are becoming clearer and more promising. At the same time, one of the main arguments for bullish investors in recent years - the management's generous attitude towards share buybacks - remains unchanged. During the last reporting quarter, the company bought back 613 million of its ordinary shares, equivalent to around 77 million ADRs, for a total of $5.8 billion. This reduced the number of shares by 2.3%, and it appears that the company has no intention of stopping. That approach to rewarding investors through share buybacks seems quite justified to me. Firstly, the projected dividend yield for the next few years is below 2% annually, so shareholders should get BABA's FCF somehow anyway. Secondly, the company's stock remains very cheap, trading at less than 10 times next year's earnings and at an FCF margin of ~11.4% (free cash flow relative to market cap). For comparison, these metrics are roughly in the middle between those of JD.com (JD) and PDD Holdings (PDD). Yes, Alibaba's projected EPS growth over the next 2 years exceeds that of JD, so this may indicate that the existing discount to Western companies doesn't apply to similar Chinese companies. Nonetheless, we can't overlook the fact that the absolute valuation multiples suggest that the company is undervalued by the market (also reflecting the broader undervaluation of the Chinese market as a whole, as can be concluded from the data above). Thus, considering the currently weak positioning of institutional investors in Chinese equities, I believe Alibaba will be among the first to benefit once the market sentiment shifts significantly. According to my technical analysis below, the potential growth of Alibaba stock from current levels could exceed 40% if we consider a potential rise to the nearest strong resistance level: So based on all the above, I believe the current price levels are very attractive for a speculative purchase in the medium term. Again, looking at the long term, I have some doubts about how long the potential recovery movement mentioned above can last. I am not particularly fond of the CCP's approach to reviving growth in the financial markets. However, a decline like the current one in China follows a logical pattern, and when institutional investor positioning decreases and the market becomes extremely cheap relative to others, it often leads to a medium-term reversal. According to the analysts at BCA Research, this reversal is in the offing in the Chinese market. Against this backdrop, I believe Alibaba will be one of the leading stocks in this potential recovery because, firstly, the company is very cheap. Secondly, if we look at the performance of each segment, the business is doing a good job despite the generally stagnant economy in mainland China. Thirdly, from a technical perspective, the stock appears to be oversold: After months of consolidation around the $70-80 mark, I believe BABA could rise significantly from here. With all this in mind, I'm not raising my rating from "hold" to "buy", but I am much more optimistic about Alibaba stock in the short to medium term. Thank you for reading!