Alibaba Stock: Be greedy when others are scared (NYSE: BABA)
I am very bullish on Alibaba (NYSE: BABA) Inventory. I strongly believe that the market has priced in too much negativity and pessimism over reality and investors are well advised to follow one of Buffett’s main maxims:
Be greedy when others are afraid.
Alibaba has grown at a 5-year CAGR of over 42%, but the company’s shares are trading at a PE of around x17. This indicates a clear undervaluation.
Of course, I understand that investors are worried about possible ADR delisting, the slowing Chinese economy, and the CCP’s crackdown on internet/tech companies. However, just as a bull market peaks in the most bullish conditions, a bear market peaks in the most bearish conditions. Although investors should study and understand the risks, I personally believe that Alibaba stock will rebound strongly from current price levels below $100/share.
Personally, I see more than 50% upside for BABA stock, as I calculate the company’s fair value with a residual earnings model anchored on fundamentals and analyst consensus estimates. My target price is $133.92.
A top notch company
Alibaba is one of the largest e-commerce companies in the world. The company operates three main shopping sites Taobao, Tmall and Alibaba.com, which cumulatively serve some 828 million monthly active shoppers (fiscal year ending March 31, 2021).
Alibaba also has stakes in several innovative internet/tech companies such as Youku (video entertainment), Pony.Ai (autonomous driving) and most notably Ant Group (the world’s largest financial services company). Alipay serves almost the entire population in China. The platform has 1.3 billion users and 80 million merchants. Notably, Alipay’s total payment volume was over $19 trillion in 2021.
Additionally, Alibaba is a dominant force in the Chinese cloud market with around 37% market share. The Chinese cloud market is expected to grow at a 4-year CAGR of over 25%, reaching $85 billion in 2026. As the market leader in China, Alibaba is poised to benefit from this supercharged cloud growth. Cloud is also a vertical business sector where the company is expected to take advantage of government tailwinds as the Communist Party of China actively supports efforts to digitize the economy and has made cloud development a key priority in the development plan. five-year party.
In the past fiscal year, the Alibaba Group generated total revenue of about $134.5 billion and recorded an operating profit of about $15 billion. Specifically over the past five years, from March 2017 to March 2022, Alibaba has seen incredible 5-year growth of 42%. For reference, that’s almost double the growth rate of Amazon, which grew at a 5-year CAGR of 22% over the same period. Alibaba ended fiscal 2021 with $9.8 billion in net income available to common shareholders.
Alibaba’s balance sheet is very strong: as of March 2022, the company had $71.7 billion in cash and cash equivalents and only $27.85 in total financial debt. That makes Alibaba a net creditor of around $43 billion, or 17% of the company’s market cap. Additionally, Alibaba’s business operations, despite the strong growth, are cash accretive. In fiscal 2021, the company generated operating cash of $22.5 billion. Under these circumstances, it should come as no surprise that the company announced a $25 billion share buyback program (more than 10% of outstanding shares) in March 2022.
Alibaba will announce its results for the April to June quarter on August 4 before the market opens. Analyst consensus calls for total revenue of $30.21 billion and EPS of $1.56.
The buying opportunity
Despite strong company fundamentals, Alibaba stock suffered a dramatic sell-off. Shares of BABA are down around 70% against ATH as the company has been under pressure from multiple headwinds: ADR delisting fears, a slowing economy in China, Covid-19 lockdowns. 19 and an aggressive regulatory crackdown that began with the cancellation of Ant Group’s November 2020 IPO.
Alibaba is a quality company, and the stock’s undervaluation is no secret to investors. The key question is: is the worst behind and can investors safely invest in Alibaba shares?
I firmly believe that a safe investment does not exist. In my opinion, any investment opportunity should be judged by its price. And the lower the price, the less risky an investment becomes. So, investing is all about risk/reward. Given Alibaba’s extremely depressed valuation – now the company’s shares are trading at a PE of around x17 – I argue that an investment is warranted.
Additionally, there are signs that all of Alibaba’s headwinds are easing and the negativity surrounding the stock has peaked. The CCP has repeatedly tried to let investors know that the internet/tech crackdown is coming to an end and that the party actively supports the healthy expansion of digital platform economies (here, here, here).
In addition, to combat the slowing economy, China has pledged to strengthen fiscal economic support – with particular emphasis on digitalization. While Western economies are hawkish on fiscal and monetary stimulus – ending a decade-long easing cycle, China is one of the few economies that appears to be starting a new round of stimulus.
Analysts agree with the bullish thesis. In general, analysts are very bullish on Alibaba shares. Based on the ratings of 44 analysts, 33 analysts give a strong buy rating, 8 are rated buy, and 3 give a hold recommendation. There is no sell or strong sell rating. The average price target is $155.47/share, indicating more than 70% upside.
Valuation of residual profits
Now let’s look at the valuation. What could be the fair value per share of Alibaba shares? To answer the question, I built a residual income framework and anchor on the following assumptions:
- To forecast EPS, I rely on analyst consensus forecasts available on the Bloomberg Terminal through 2025. In my view, any estimate beyond 2025 is too speculative to be included in a valuation framework. But for 2-3 years, analyst consensus is usually pretty accurate.
- To estimate the cost of capital, I use the WACC framework. I model a three-year regression against the Hang Seng to find the stock’s beta. For the risk-free rate, I used the yield on 10-year US Treasuries as of July 22, 2022. My calculation indicates a fair WACC of around 9.8%. I adjust upwards to 12% to reflect the company’s idiosyncratic market risk.
- To calculate Baidu’s tax rate, I extrapolate the 3-year average effective tax rate from 2019, 2020, and 2021.
- For the terminal growth rate, I apply expected nominal GDP growth plus one percentage point to reflect a favorable growth outlook for Alibaba’s high-potential initiatives
- I am not modeling any stock buybacks to further support a conservative valuation.
Based on the assumptions above, my calculation returns a base target price for Alibaba of $133.92/share, implying a material upside of more than 50%.
I understand that investors may have different assumptions regarding Alibaba’s required return and terminal business growth. Thus, I am also attaching a sensitivity table to test different hypotheses. For reference, red cells imply overvaluation relative to the current market price, and green cells imply undervaluation. In particular, all the combinations tested imply an undervaluation!
Investors should be aware of the following downside risks that could cause Alibaba’s stock to deviate significantly from my base target price of $133.92/share:
First, China’s economy is currently under pressure from multiple headwinds, including inflation, the real estate crisis, and COVID-19 related lockdowns. Should China’s economy slow more than expected and priced in, investors should adjust expectations for monetization of Alibaba’s business in the short/medium term accordingly.
Second, Chinese internet/tech companies are highly exposed to regulatory risk. Although the worst seems to be behind us, the high risk exposure persists and will probably never fade completely.
Third, much of BABA’s stock price volatility is currently driven by investor sentiment towards ADRs and Chinese risk assets. Thus, BABA’s stock price could exhibit high price volatility even if the company’s business fundamentals remain unchanged.
Alibaba stock is down 70% against ATH, but the company remains a global powerhouse with huge long-term potential. Trading at a PE of less than x17, despite growing as a start-up, I argue that selling Alibaba could offer long-term oriented investors, who can withstand short-term share price volatility, a generational buying opportunity.
Personally, I see more than 50% upside for BABA stock, despite cautious and conservative valuation assumptions. Strong purchase.
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