Alibaba: Still Waiting For The Bull Run

Summary

  • Alibaba investors have had a rough start to 2022, with shares down 25% YTD.
  • I break down the three most likely outcomes for investors over the next 5 years.
  • Shares currently trade at 11x earnings, and are even cheaper if you take the company’s balance sheet into consideration.
  • The company boosted the buyback program to $25B at the end of March.

Markets have had an interesting start to 2022. I have had several of my biggest positions perform well, as Enterprise Products Partners (EPD), Magellan Midstream Partners (MMP), and Altria (MO) are all up double digits which has helped weather declines in just about everything else. Alibaba, which is still my third largest position, has continued to be a pain point and is down 25% YTD. My first article was a breakdown of the company, and the second article was an update on analyst views of the company and the potential LEAPs that investors might consider if they are bullish on Alibaba. This article will focus on the potential outcomes that I see for investors who plan to ride it out.

Investment Thesis

Alibaba is still the best option for American investors looking to invest in a piece of the Chinese economy. The company is still materially undervalued, but that doesn’t seem to be in question for most investors. The company boosted its buyback program to $25B, which is huge relative to the 270B market cap. I will go over the three outcomes that I view as most likely, as well as a brief update on the valuation. I think the risk/reward equation is attractive today and investors willing to buy shares of Alibaba while it’s unpopular could see huge returns.

Outcome #1 – The Good

Personally, I think the best-case scenario is also the most likely. I think cooler heads prevail and regulators figure out a solution that works for both the Chinese and the US when it comes to ADRs, delisting, and other fears that have been in the news on a weekly basis will not be an issue. Investors will begin to open up to the idea of owning Chinese stocks again, and money starts to flow into large Chinese stocks like Alibaba, Tencent, and JD, as well as ETFs like the China Internet ETF (KWEB). It won’t happen overnight, but I think we are past peak fear when it comes to China and its markets.

Outcome #2 – The Bad

If it turns out we are not past peak fear, things could continue to get worse for shareholders. Shares peaked out in 2020 above $300, and it has been a choppy ride down and to the right ever since. I think that the worst is behind us, but it is possible that things could continue as they have been for the last year and a half for Alibaba. I think that this outcome is unlikely, but the market has consistently sold Alibaba for nearly two years. It is possible that the selloff continues, and shares continue to languish and frustrate investors.

Outcome #3 – The Ugly

The last scenario is the worst-case scenario for Alibaba investors. This would be if regulators attack the ADR structure for Alibaba. It could be a delisting, or some other rule or regulation that makes it more difficult for American investors and institutions to invest in Alibaba. Investors can still hold shares on the Hong Kong exchange, but the ADRs are the most convenient for US investors and brokerages. While China and America have had a rocky relationship over the last decade, both countries (and their economies) need the other to continue to function. I view this outcome as highly unlikely. Investors should weigh these possibilities and decide if the valuation is attractive enough for them.

Valuation

If you have read most of the articles on Alibaba, most authors seem to agree that the company is undervalued. Some aren’t as bullish because of the China risk, but I think shares are too cheap to ignore, especially when you consider the quality of the business. Shares currently trade for 11x earnings, which is just way too cheap for a company that is growing revenue like Alibaba. I’m curious to see what yearend earnings look like, but I think the company will be earning significantly more in 5 years than it is today.

Price/Earnings (FAST Graphs)

You can also remove cash and other short-term assets to conclude that Alibaba is even cheaper than it looks at first glance. If you think that the risk/reward is skewed to the upside and have an iron stomach and a plan to hold for years, Alibaba could provide impressive returns. One of the other pieces that I like is the buyback program that was increased in late March.

The company boosted its buyback program to $25B, which left approximately $15B on the authorization at the time. Unlike many of the American companies buying back stock at elevated valuations, Alibaba is cheap, and buybacks done at these prices will be a huge benefit for long term shareholders. I’m curious to see what happens in the next year with the share price and buybacks, but I plan to hold onto my shares barring any unforeseen changes.

Conclusion

Alibaba is one of a few large cap stocks available today where the risk/reward is highly skewed to the upside. Shares have been selling off for nearly two years due a stream of negative headlines, but the business is still in good condition. The valuation is very cheap at 11x earnings and the buyback program is another reason to be bullish. Investors view China as a risk due to the geopolitical complexity, but I think there are three outcomes that are most likely for investors.

The first (and most likely, in my opinion) is that the status quo wins out when it comes to US and Chinese relations, the ADR continues to trade on the NYSE, and money starts to flow back into Chinese stocks, ETFs, and other assets. The second outcome is that things continue to go poorly for investors even without any material changes to the listing or US/China relations. This could happen, but I think peak fear is behind us when it comes to shares and I don’t think this outcome is very likely.

The third outcome is that the US/China relationship deteriorates, and it leads to a delisting or regulatory change that makes it more difficult for US investors and institutions to invest in the stock. Investors should decide for themselves on the most likely outcome, but I think investors willing to buy Alibaba while it’s unpopular could see impressive returns over the next couple years.

Author: BeanKounter Capital, SupChina

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