Alibaba Looks Like Amazon In 2002
- Last year, Alibaba stock entered a pronounced downtrend thanks to macro concerns and a crackdown by the Chinese government.
- Its fundamentals have deteriorated a little, but not so much that it makes the stock un-investable.
- This is very similar to the situation Amazon was in 2002.
- After its 2002 drawdown, AMZN went on to deliver a market beating return over two decades.
Alibaba Group Holding stock has seen its fair share of challenges. Between China’s tech crackdown, a COVID-19 outbreak, and declining retail spending, there have been many curve balls thrown BABA’s way. However, the company is doing better than many people think it is. Although earnings are declining, revenue is still growing – albeit at a slower pace than in the past – and the company is working on many new projects like chips and cloud computing. Chips and cloud services were big winners for companies like Apple and Amazon, so there is reason for optimism toward Alibaba’s future trajectory.
Speaking of Amazon, that stock is a useful case study when it comes to understanding Alibaba. The two businesses have a lot in common, including:
- Core eCommerce operations.
- Cloud computing operations.
- High market share in the countries that are their “home bases.”
These qualities make Amazon comparable to Alibaba. The two companies aren’t identical – Alibaba relies on third party vendors much more than Amazon does, and China is a very different market than America. But there are enough similarities that we could describe the two companies as being in the same sector.
There’s another trait that Amazon and Alibaba have in common:
Their stock market performance. BABA’s price trend in 2021/2022 is very similar to Amazon’s trend in 2000-2002. In both cases, the shares fell by high double digit percentages while revenue grew. When you’ve got a company whose stock price is declining while sales grow, you’re looking at an investment with the potential for future appreciation. Indeed, that happened with Amazon starting in 2002. That year, the company’s stock fell while its losses got smaller, paving the way for future growth. In BABA’s case, the higher revenue growth is not translating to earnings growth – a declining stock portfolio, investments in subsidiaries, and higher taxes are taking a bite out of fundamentals. On the flipside, BABA (unlike 2002 Amazon) has positive earnings already, so it can support its stock price through future buybacks. Taken as a whole, these factors suggest that BABA is set for a rally much like the one Amazon experienced after its 2002 crash.
One thing that Alibaba has in common with Amazon, especially 2002-era Amazon, is its competitive position. Alibaba has one very large competitor, JD.com, and a host of smaller ones. This is similar to the situation Amazon faced in 2002, when eBay was king of the eCommerce castle. In the long run, Amazon prevailed over eBay, and there are reasons to think that Alibaba will prevail over JD, too.
One of those reasons relates to profitability. JD is a retailer that holds and sells inventory directly, Alibaba is mainly a platform for third party retailers. Amazon is a mix of both.
Alibaba’s “third party seller” model results in high margins because it does not require holding inventory. BABA has fulfillment centers, which cost significant sums of money, but not on the level of holding inventory. Alibaba’s model incurs minimal host, mainly marketing and maintaining web infrastructure. JD’s, by contrast, incurs high costs. So BABA will likely earn more profit than JD if the two companies’ revenue levels are comparable. Indeed, their revenue is pretty comparable: JD actually had about $20 billion more of it than BABA did in the trailing 12 month period. However, BABA had far more profit. That’s largely because of Alibaba’s low cost business model.
Of course, JD’s growing sales are a threat to Alibaba. Just because JD earns less profit doesn’t mean it won’t cut in on Alibaba’s action. However, Alibaba’s higher margins give it more opportunities to invest in its business. Over the last decade, Alibaba has built a cloud business, bought several companies, and launched a partially-owned payments platform. These kinds of things would be hard to pull off with JD’s margins. So, between JD and BABA, the latter is better positioned to grow into an Amazon-style conglomerate.
Alibaba’s Financials: the Amazon Comparison is Clear
Alibaba’s recent stock performance has been similar to Amazon’s in 2000-2002. Its financials are also similar to Amazon’s at that time period, only far better. In the most recent 12 month period, BABA delivered:
- $134.5 billion in revenue.
- $49 billion in gross profit.
- $14.9 billion in operating income (“EBIT”).
- $9.8 billion in net income.
- $9 billion in levered free cash flow.
These figures give us a 7.2% net margin and a 36.5% gross margin. The net margin might not look that impressive but this is going off of GAAP earnings, which are affected by the performance of BABA’s stock portfolio. Substituting cash from operations for net income and we get a 16.3% CFO margin. Alibaba’s margins have fallen somewhat since the company’s record breaking 2020/2021 fiscal year, but they should start to climb again. A lot of the decline in BABA’s margins has been due to its stock portfolio declining in value. Chinese stocks are in a bullish trend this quarter; if they end the quarter in the green, then we could see BABA’s margins improve.
This is similar to where Amazon was in 2002. Its stock price was declining, its revenue was rising, and its equity investments were going down. It was not profitable in 2002, so Alibaba compares favourably on that front. However, AMZN’s net loss was shrinking that year whereas BABA’s earnings are declining, so “2002 Amazon” wins on growth.
Having explored Alibaba’s financial performance, we can turn to its valuation. I’ll leave the Amazon comparison alone for this section because Amazon is nothing like Alibaba when it comes to valuation.
One of the most appealing things about Alibaba stock today is its price. The company is very cheap relative to its underlying assets, earnings and cash flows, and will look even cheaper if earnings growth resumes later this year.
According to Seeking Alpha Quant, BABA trades at the following multiples:
- Adjusted P/E: 12.
- GAAP P/E: 28.
- EV/EBITDA: 11.3.
- Price/sales: 1.98.
- Price/operating cash flow: 11.7.
These multiples suggest that BABA is cheap. Certainly, they’re much lower than the multiples you’ll find on U.S. tech stocks of similar size. Doing a discounted cash flow analysis on BABA yields a similar result: even with conservative growth assumptions, the stock ends up being worth more than its current stock price implies.
In the trailing 12 month period, Alibaba grew revenue at 18%. In the two recent quarters, it grew closer to 10%. For the sake of conservatism, we’ll use the lower end of BABA’s recent quarterly growth as our revenue assumption.
Now let’s look at costs. In 2021, BABA’s COGS was $64 billion and operating expenses were $28 billion, for a total of $93 billion in cash costs. These combined costs grew by 28% to $119 billion in 2022. That would suggest that Alibaba’s costs are growing much faster than revenue. However, if we zero in on the most recent quarter, we see the cost growth slowing down compared to earlier in the year. COGS for Q4 came in at $21.9 billion and operating cost at $7.6 billion–down from $7.8 billion in the prior year quarter. Overall, COGS + operating costs combined grew at 10% for the quarter. We know that Alibaba is actively working at reducing costs right now, so I will again forecast based on the quarter rather than the year. The result of these assumptions is 10% growth in both revenue and costs. I will ignore interest expense in my model because BABA’s “interest income” includes stock market fluctuations, which are impossible to predict. I will use 25% as the tax rate because BABA recently lost its tax credits and, as a result, now pays China’s standard 25% tax. These assumptions yield the following model:
|2022 (BASE YEAR)||2023||2024||2025||2026||2027|
|Revenue per share||$50||$55||$60.5||$66.55||$73.2||$80.52|
|Costs per share||$44.35||$48.78||$53.66||$59||$64.93||$71.42|
|EBIT per share||$5.65||$6.22||$6.84||$7.55||$8.27||$9.1|
As you can see, earnings dip briefly in 2023, mainly due to the fact that 2022 hadn’t yet seen four full quarters with higher tax rates. In 2024, earnings resume a modest upward trajectory.
The end result is a pretty underwhelming 6.2% CAGR growth rate in earnings, which stems from our conservative assumptions. Actual growth could be stronger, but we’ll use what we’ve got. If we discount the cash flows above at the 3% 10 year treasury yield, we get:
|(1 + r)^N||1.03||1.0609||1.093||1.125||1.159||N/A|
So we’ve got $25.91 worth of discounted cash flows in five years. If we assume that BABA produces no growth after that, then the terminal value is $227. So, we have a total present value of $253 – even when we assume extremely slow growth!
Risks and Challenges
As we’ve seen, Alibaba stock is undervalued based on both multiples and discounted cash flows. If the company just grows modestly in the next five years, its stock will come to be worth more than it is today. However, there are many risks and challenges for investors to watch out for, including:
- Political risk. Alibaba is subject to two forms of political risk: domestic political risk (e.g. a renewed tech crackdown), and international political risk (e.g. tensions between China and the U.S.). Right now, China is easing up on the tech crackdown, which is part of why Chinese stocks are rallying, but you can never discount the possibility that the government will go back into crackdown mode later. Likewise, there is always the possibility that tensions between the U.S. and China over Taiwan will flare up and cause more concerns about delisting or tariffs.
- Revenue deceleration. Alibaba’s revenue growth decelerated significantly in the past year. Its five year CAGR revenue growth rate is 40%, the TTM growth rate is only 18%. So BABA’s growth is definitely slowing. If it slows down more, then perhaps BABA won’t hit the 10% revenue growth my model assumed, and it will be worth less than what my model estimated.
- COVID outbreaks. China is still committed to a “COVID zero” model, meaning that it is willing to bring in pretty strict lockdowns for only modest numbers of COVID cases. This fact contributed to China’s recent 11% decline in retail spending. If we see more lockdowns, then BABA’s sales growth could slow down considerably, contributing to revenue deceleration.
The risks above are very real. Nevertheless, Alibaba stock is cheap enough to make the risk worth assuming. Even assuming very little growth, the stock’s future earnings have a present value of about $250. That’s considerable upside to today’s prices. If growth accelerates, then we could see a true Amazon-style multi-decade rally taking us to dizzying highs.
Author: Growth at a Good Price, Seeking Alpha