- Alibaba has rallied strongly, and technical indicators support further upside.
- The growth story continues to hold. The important question though is profitability.
- This might be the last chance to add BABA at a reasonable price.
Alibaba Group Holding has staged a convincing rally in the last few weeks, and I believe we should see this extend into 2022 and beyond. The company may be under the thumb of the CCP, but that doesn’t change the compelling growth story. Furthermore, Alibaba’s challenges are not unique to the company, with many other Western businesses facing regulatory crackdowns in the last year. Lastly, technical indicators are also pointing up, making me believe that BABA could be one of the best investments of the next few months. With that said, future profitability could be a concern for investors.
Alibaba: So what?
BABA’s shares have tumbled due to concerns about the CCP’s stance against “big tech” and certain business practices. This all started with the halting of the Ant Financial IPO and the “mysterious disappearance” of Jack Ma. However, in the last week, we have seen Ma reappear in Hong Kong, as well as encouraging evidence that the Ant IPO may be back on the table. Alibaba has rallied over 10% since hitting a local bottom at around $150/share, and investors are now wondering; what’s next?
The main concern with BABA, in my opinion, is far from fears of delisting or foreign investors somehow getting shafted by the VIE structure, which is the idea that the CCP could interfere with Alibaba’s operations in a way that will hurt investors. In essence, the concern is that Alibaba has been compromised and that the company may forfeit growth and or profitability to serve the needs of the Chinese government. My objections to this theory are two-fold:
Firstly, aside from the Ant IPO being halted, there is scant evidence that the CCP will interfere with Alibaba’s business. The company is a national champion, and its interests are aligned with those of the government. Most importantly though, the current discount attributed to Alibaba shares seems unfair, especially given that the speculation surrounding a regulatory crackdown could just as easily be applied to the big tech companies of the West.
Facebook, Inc., for example, has been in hot water following multiple “whistleblower” reports. On top of that, the company has seen analysts rerate its earnings potential following Apple Inc.’s changes to its privacy settings. While this latter event is the result of a private company’s actions, it still serves to explain the risks that all of these technology companies face.
All these companies rely on data, and both individuals and governments around the world agree that this is something we should have more control over. This problem isn’t limited to Alibaba, and western companies like Facebook and Alphabet face similar challenges while being a lot more richly valued.
Growth or Profitability?
Having said this, it’s important to look at what might happen if, indeed, for one reason or another, Alibaba’s fundamental business changes over the next few years. My biggest concern here would be that margins could contract significantly. But first, let’s look at what BABA’s value is according to recent estimates and using a 5-year DCF Growth Exit Model provided by Finbox.
As we can see, using conservative growth and earnings estimates, the model estimates a fair value of $280/share. This forecast predicts a 5-year revenue CAGR of 18.2% and an EBITDA margin of 23.1%. As I’ve said, this is conservative if we look at current estimates on Seeking Alpha.
The scenario above would make for an attractive investment. But what if margins keep falling? This is the trend that profitability has been following over the last 5 years, and we could see margins contract even more. Geopolitical tensions and supply shortages could easily render Alibaba less profitable, and in fact, I believe we are seeing this taking place right now.
In recent news, Alibaba unveiled that it would be premiering its in-house server chips. This can be seen as a good move in the right direction given the recent shortages in the semiconductor market, but will it pay off long-term? I question whether it is a wise decision for BABA to pour money into developing its chips when this is something that can be outsourced. Developing the necessary infrastructure and expertise for this will be expensive, and I see anything that strays from BABA’s core business as a move in the wrong direction.
Ultimately, if profitability continues to decline, we could be left with something that looks like this:
In the forecast above, we are assuming the same level of growth as before, but with a steady decline in margins, resulting in a 5-year EBITDA margin of 16.2%. In this case, BABA would be considered perfectly priced, and there would be little upside left.
Is this scenario realistic? Given the current trend and future challenges, it is certainly possible. Margins will be the most important metric to look at in the upcoming quarterly results in my opinion.
Technicals are Great
On a more short-term basis, it is worth mentioning that technicals for the stock look very compelling.
Alibaba stock formed a bottom at the beginning of October, and it has since rallied over 10%. The stock began to trade over its 50-day MA and we saw the magi cross with the 200 days MA take place on the 7th of October. As I write this, the stock is down for the day and hovering just above the support region at $172. Holding this support is key, and could set up the next big rally. With the RSI showing oversold conditions, this could be a great spot to open a trade with a tight stop or simply add more to your position.
In conclusion, I still believe Alibaba has a long way to go in the remainder of 2021 and through 2022. The stock is severely discounted based on what I can only define as speculation regarding the CCP, which has done nothing to hurt BABA but halt the Ant Financial IPO. Profitability will be a real challenge for the company, but this won’t matter if BABA can produce enough growth. Ultimately, BABA could adjust its operations to increase profitability if this is what investors want, but the best plan of action for now could be to go for growth. In any case, BABA continues to be a high conviction long-term hold in my book, and this may be the last chance to add the stock at a reasonable price.
Author: The Value Trend, Seeking Alpha