Alibaba Group Holding Limited (BABA) reports its FQ3’22 card on February 24, 2022. We believe it will be a highly anticipated earnings card as investors seek clarity over BABA’s growth deceleration over the past year. Nonetheless, Alibaba stock has undoubtedly been buffeted by reasons beyond its fundamentals, most notably by the long, outstretched arms of the regulators. China is keen to ensure that its most influential corporate entities do not engage in the “disorderly expansion” of capital we saw in the past. We believe such adjustments are still occurring and don’t think BABA nor its closest peers are out of the woods yet. Alibaba has also been discernibly impacted by the macroeconomic slowdown, continued weakness in consumer spending, and property market turmoil. Moreover, since most of its revenue relies on consumer discretionary spending, its consensus price targets have also been revised downwards significantly. Therefore, investors’ confidence in Alibaba’s ability to navigate what is arguably its most significant crisis since its start as a public-listed entity has also been impacted.
We discussed in our previous article that BABA stock’s valuation seems cheap relative to its fundamentals. As a result, Alibaba stock is trading like a value-play now. But, we still believe that investors should remain patient while BABA navigates its most profound headwinds. Moreover, the significant correction in US growth stocks should also have provided a gamut of attractive alternatives. Therefore, growth investors are spoilt for choices now. We discuss more below.
BABA Stock’s Free Cash Flow Yield Exceeds 7%
The narrative on the highly attractive valuation of Alibaba stock has been repeated often enough. And we concur based on this perspective. BABA is still generating robust free cash flow (FCF) even though its FCF margin has declined. As a result, Alibaba stock is trading at an NTM FCF yield of 7.2%, well above its 3Y mean of 4.5%. Furthermore, it’s also ahead of its Chinese and US mega-tech peers, as shown above.
Therefore, from an FCF yield perspective, we think there’s no doubt that Alibaba stock looks attractively priced now. Furthermore, despite a markedly declining last-twelve-months (LTM) free cash flow margin as seen above, the market’s assessment over what Alibaba stock is worth seems incredulous. Alibaba has expanded its business from its traditional focus on advertising revenue to omnichannel retail, logistics, and cloud computing. It’s also investing aggressively to address its long-term growth drivers, but these would take time to realize.
But, The Street’s Most Pessimistic Forecasts On Alibaba Have Been Right
Readers can observe from the above chart where BABA stock average consensus price targets (PT) have often been “too optimistic” over the past three years. It seems that BABA stock has trended closer to its most pessimistic PTs, notably since BABA stock’s November 2020 peak. Moreover, BABA’s PT has also been revised downwards consistently, as its fundamentals have gotten worse as China’s economy continues to slow.
Readers can also observe the consistent deterioration in Alibaba’s margins over the last three years. Of course, the investments in the lower margins businesses have also contributed to the dilution in its margins. However, the macroeconomic impact from China’s slowing growth continues to affect its margins. Coupled with the need for more aggressive investments to fend off competition and develop new long-term growth drivers, we believe that the stock seems to lack a near-term catalyst.
Furthermore, we can also glean from the charts above and observe that the mean consensus estimates on Alibaba have also been revised markedly downwards since December. The macroeconomic situation continues to be in a state of flux. It’s further pressured by the persistent COVID-19 related lockdowns. China’s property sales in January continued to decline significantly, down 36% YoY after December’s 35.2% drop. China Real Estate Information also weighed in that the property market downturn is expected to continue moving forward. Therefore, consumers’ confidence will likely remain depressed, which doesn’t bode well for Alibaba’s retail-focused business segments.
Furthermore, China’s zero-COVID policy has continued to wreak havoc on its tourism sector and consumer spending. For instance, China posted domestic tourism revenue at half of its pre-pandemic 2019 numbers. It rose off a lower base in 2020 to CNY2.92T (up 31% YoY). But, it was only “51% of that in 2019 and the second-lowest since 2013, according to data released by the Ministry of Culture and Tourism. Travelers made 3.2B domestic trips, up 12.8% but still 46% lower than in 2019.”
Furthermore, tourism spending in the recent Spring Festival points to weakness ahead. Tourism revenue for the Festival declined 3.9% YoY to CNY289B, and domestic trips fell 2% to 251M. China’s zero-COVID policy has likely also contributed to the weakness, as Absolute Strategy Research added (edited): “More people traveled home for the holiday this year than last, but the data we have so far suggest they mostly stayed home and total spending was fairly weak.”
Furthermore, the most pessimistic analysts have also revised their estimates downwards for Alibaba. Notably, they are markedly lower than the mean consensus presented earlier. But, these analysts have proved their prescience of Alibaba stock’s forecasts over the past three years compared to the average consensus. BABA stock seems to be consolidating now. But, there aren’t enough near-term catalysts to turn more positive over its medium-term outlook yet. We believe there is still a period of digestion for Alibaba until its revenue estimates reach a bottom. We think it could come nearer to the end of 2022, as certain macro headwinds could start to unwind. These include the supply chain snafu and regulatory clarity.
Given that its Central Bank has also recently relaxed its monetary policy, we should also closely monitor its progress. Furthermore, China’s mRNA vaccine makers have also shown positive progress in developing mRNA vaccines. The jointly-developed ARCoV vaccine found neutralizing antibodies in 80-95% of the participants in its Phase I trial. “The vaccine is [also] in Phase 3 trials overseas including Mexico, Indonesia, and Nepal.” We believe that the successful commercialization of its mRNA technology could lead to the progressive unwinding of its “harsh” lockdown that has severely impacted China’s economy. We think this could be the near-term catalyst for BABA stock to be re-rated moving forward. Therefore, we encourage Alibaba investors to monitor these developments closely.
Until Then, Our Hold Rating Remains For BABA Stock
The most pessimistic PT for BABA stock is $140, representing a 14.5% implied upside. But, if you take a meaningful discount to account for BABA stock headwinds, then it’s at most fairly valued, if not overvalued. Therefore, we encourage investors to remain patient for more data points before jumping into BABA stock again. Moreover, the growth stocks correction in the US market has presented a plethora of alternative opportunities to consider. So, there’s no need to rush into BABA stock for now.
As such, we reiterate our Hold rating on BABA stock.