Alibaba Stock: New Retail Is An Under-Appreciated Long Term Growth Driver (NYSE:BABA)

Alibaba headquarters

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A Relook One Year On

A year ago in 2021, I posted two in-depth analysis on Alibaba Group Holding Limited (NYSE:BABA), documenting the strong fundamentals, growth prospects, and attractive valuation of the company. Many of the points raised still remain very valid today, as Alibaba has continued to pose excellent financial and user metrics growth in their important cloud and computing segments. For reference and comparison of theses, you can view my past articles here.

A year on, Alibaba’s share price has dipped by almost 50%, and this has been mostly triggered by regulatory and macro-environmental concerns. Through it all, Alibaba’s strong fundamentals remain unshaken and I am more bullish on Alibaba today than ever before. In this article, I will re-assess some of my previous pointers following FY22’s results and recent regulatory developments, as well as put forth three new theses on why I believe Alibaba today is extremely well positioned for long term outperformance.

Since Alibaba is a widely covered company, I will be focusing on lesser touched on aspects and perspectives of the businesses hence if you would like a fuller analysis on the different business segments, feel free to read my two previous articles.

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Data by YCharts

Thesis 1: New Retail Segment Is An Under-Appreciated Driver Of Growth

Much of the bull/bear discussions surrounding Alibaba have been regarding the company’s gradually falling e-commerce market share with the rise of competitors such as JD.com (JD) and Pinduoduo (PDD). Additionally, some analysts have voiced concerns that Alibaba’s e-commerce revenue growth will inadvertently slow since the industry is nearing maturity in China. Hence, my main thesis in this article will be too deep-dive Alibaba’s new retail segment which seems to have been overlooked by many as a long term growth driver..

New Retail Segment Continues To Pose The Highest Growth Rates Despite A More Volatile Business Environment In FY22

As a recap, new retail refers to the blending of online and offline commerce by providing consumers a seamless switch between both platforms. I mentioned last year that new retail would serve as new avenues of revenue growth for Alibaba, and I believe that results and development over the past year continue to solidify this thesis.

Alibaba's New Retail Revenue Growth

Alibaba’s New Retail Revenue Growth (Author’s compilations from Alibaba’s 10-Ks)

To ascertain new retail revenue, I have taken the figures from Alibaba’s “Direct Sales & Others” revenue line which the company has described as revenue from Sun Art, Freshippo and Tmall Supermarket — all of which are part of the new retail strategy. Hence, while the exact new retail revenue might differ from these amounts, I believe that it is a good enough proxy for analysis.

For FY22, we can see that new retail revenue has continued to grow by 55% y-o-y, with a 4Y CAGR of over 101%! New retail now makes up 35% of total commerce revenue, and is now a significant revenue driver for Alibaba.

This is huge for Alibaba, as we are currently only five years into the projected twelve years projected timeframe for new retail to reached a more “developed” phase, a timeline set by founder Jack Ma back when this concept was launched. Despite its relative size, new retail is still Alibaba’s fastest growing segment, over cloud and international retail at 24% y-o-y. Given that Alibaba is already posing stellar results for new retail, I believe this segment will continue to be a long run revenue and growth driver for both the local commerce segment and company in general.

Consolidation Of Sun Art Coupled With Freshippo Greatly Strengthens Alibaba’s Omni-Channel Supermarket Business

Now, I will turn to the more qualitative aspects of the segment to explain why Alibaba’s new retail businesses are well positioned for growth. At the heart of Alibaba’s new retail strategy are hypermarkets and supermarkets. This is because there are many dimensions to the consumer experience in this area, and numerous opportunities for innovation, as noted by Alibaba’s President Michael Evans.

One key piece of the strategy is Sun Art Retail, a leading supermarket in China which Alibaba bought an initial 36% minority stake back in 2017 to kickstart its new retail roadmap. In 2020, Alibaba acquired a majority stake in the retailer, giving it full control and access to its stores, inventory and networks. Without Sun Art, Alibaba’s only physical supermarket chain was its self-developed Freshippo “smart-supermarkets”, commanding only 320 storefronts as of 2Q22. Hence, the consolidation of Sun Art adds over 500 physical stores, more than doubling Alibaba’s physical footprint and distribution network for supermarkets.

Alibaba's New Retail Strategy & Ecosystem

Alibaba’s New Retail Strategy & Ecosystem (Alibaba Investor Day 2021)

With this, Alibaba’s focus is on integrating all their new retail brands, Sun Art, Freshippo, Tmall Supermarket (grocery arm of the Tmall e-commerce app), by digitalizing the brick-and-mortar brands and connecting inventory, delivery and distribution networks to value-add the e-commerce platforms. This means that inventory for a Tmall supermarket product can be stored at a Freshippo store closest to a consumer, and this will allow same day delivery either through Freshippo’s delivery fleet or Alibaba’s own Cainiao logistics network.

To give concrete examples, Sun Art had already begun to integrate its inventory with Tmall back in 2019. In FY22, a full year after consolidation, Alibaba has also reported strong synergies between Sun Art and Alibaba’s e-commerce arm, with Sun Art’s e-commerce sales growing to 30% as Alibaba used its e-commerce expertise to develop Sun Art’s online platforms. On the other hand, there has been a 360% increase in inventory supply to Alibaba and this further strengthens the company’s omni-channel supermarket strategy as they have greater control over their goods. Currently, Sun Art is piloting a “warehouse-based” storefront similar to Freshippo, meaning that half the store would be a forward distribution point for Alibaba’s logistics network e.g. inventory, packing and delivery point.

Sun Art & Alibaba's Synergies

Sun Art & Alibaba’s Synergies (Alibaba Investor Day 2021)

Alibaba Is Now Even Better Positioned To Scale And Capture Growth In New Retail Markets

With a fully consolidated Sun Art to complement Freshippo and Tmall supermarket, Alibaba can now start to scale their omni-channel supermarket segment as integration processes become more complete. When looking at competitors, JD.com would be the most obvious rival in this market, as they are the only other e-commerce player with an extensive network of physical stores and well-developed logistics delivery ecosystem.

With the consolidation of Sun Art, Alibaba’s MAUs for its supermarket apps now exceed 30 million, at a similar level as JD Daojia, JD’s O2O grocery arm. However, Alibaba’s figures only include those of Sun Art and Freshippo and excludes Tmall Supermarket MAUs as this number is not disclosed. I would expect the combined figure to be much larger since Alibaba’s Tmall MAU exceeds 800 million. Turning to physical storefronts, Alibaba now has a commanding lead over JD on owned supermarket locations, with JD only opening its own smart supermarket store 7Fresh last year. The chain now has 48 locations with 12 more expected to open by end 2022.

However, where JD differs is in its business model. Instead of owning supermarkets, JD engages in active partnership with retail chains such Yonghui Superstores, as well as local mom and pop stores, totaling over 150,000 storefronts from partners. It is also reported that JD is opening over 1000 new small convenience stores per day through franchising agreements, and these stores serve as delivery outpost for JD Daojia.

Alibaba

JD

Supermarket App MAUs

30m+ from Sun Art & Freshippo, excluding Tmall Supermarket

30m from JD Daojia

Main App AACs

939m

580m

Physical Network Of Supermarkets

800+ (Owned)

150,000 (Partners)

As both companies are operating different business models, Alibaba focusing on warehouse style whereas JD is going for reach, it would be difficult for me to ascertain who would be the winner. However as history has shown, there is always room for more than one player in the Chinese market and I fully believe that Alibaba is now in a stronger position to rival JD in the omni-channel grocer realm.

Beyond Sun Art’s consolidation, Alibaba can rapidly scale its physical footprint and even expand through smaller-sized stores to increase their reach. For example, Freshippo’s stores have grown by a 41% CAGR from 1Q19 to 2Q22 and are still mainly concentrated in Tier 1 cities. Given that China’s supermarket concentration is rather low and many top chains have over 1000 stores, this means that room for store expansion is aplenty in this market. With stores concentrated in Tier 1 cities, expansion into lower tier cities could also be facilitated by the strong momentum of Taobao Deals which was launched last year to target price sensitive, lower tier consumers.

Store Count Growth Of Alibaba's Freshippo

Store Count Growth Of Alibaba’s Freshippo (Statista)

Finally, new retail can also grow by leveraging on Alibaba’s network effects. As shown earlier, Alibaba has almost double the user base of JD, which can work in their favor as they upsell consumers and promote supermarket functionalities. Additionally, Alibaba currently has over 50 million paid members in their Taobao app, a considerably large pool of loyal consumers whom they can further target their new retail strategies at.

Number Of Alibaba's Paid Members

Number Of Alibaba’s Paid Members (Alibaba Investor Day 2021)

In all, I believe that new retail through omni-channel grocery is a huge market and revenue driver that seems to have been overlooked by many. Given Alibaba’s strong financial performance over the past five years, coupled with its strong O2O integrations, growth potential and possible network effects, I believe this segment will be a core growth driver for the company in the long run.

Thesis 2: Profitability And Scalability Of Cloud Will Improve Margins And Alibaba Can Now Pivot To Overseas Expansion With Their Strong Offerings

Next, cloud is a widely watched business segment for Alibaba. In 2021, I noted that Alibaba would likely turn a non-GAAP profit for this segment in FY22 and this would be value accretive as cloud will no longer drain cash flow from the company. Fast forward to today, Alibaba has indeed posed positive cloud EBITA for FY22, and the thesis has played out.

Alibaba Cloud Remains Top In Capabilities & Market Share In China To Capture Growth In The Home Market

Today, I will be reinforcing the cloud thesis for the long run as I believe that despite some unfavorable developments over the past year e.g. Alibaba Cloud losing a huge customer, Chinese government encouraging the public sector to use state owned cloud, Alibaba still commands a strong position in its home market.

In Q1 this year, Alibaba commanded 36.7% market share in China, slightly down from 39% a year ago. Such a drop is expected given Alibaba’s huge lead, as they continue to have a commanding market position lead over their closest rivals. Similarly, Alibaba is also well ahead of its rivals per Forrester Wave in terms of cloud services and capabilities.

Cloud Computing Market Share In China 1Q2022

Cloud Computing Market Share In China 1Q2022 (Canalys)

Even as tech companies and public cloud are coming under greater scrutiny and regulations, the Chinese cloud market is still expected to grow at a CAGR of 33.3% through 2025, reaching $87 billion. This is catalyzed by the country’s poorer enterprise software sector which means that public cloud infrastructure will dominate growth in the years to come as there are no good alternatives. With Alibaba remaining as the top choice, they will be able to continue to reap this growth in the years to come.

Alibaba Cloud Can Viably Expand Into Friendlier Overseas Markets Given Its Strong Suite Of Offerings Relative To International Peers

Alternatively, should growth in the domestic cloud market slow due to unforeseen reasons, Alibaba has stronger downside protection as compared to its Chinese peers, as they have the largest cloud infrastructure overseas and a package that can rival global cloud providers like Amazon (AMZN) and Microsoft (MSFT).

One key market for Alibaba would be Southeast Asia, as the region is still relatively undeveloped in terms of technology and data storage infrastructure hence Alibaba Cloud provides a strong value proposition in the region. SEA is also the fastest growing adopter of cloud computing by region, with an estimated market size of $40 billion by 2025, half that of China!

In SEA, Alibaba already has over a hundred data centers in Malaysia, Singapore, Indonesia and the Philippines among others, making it the largest cloud provider in Asia Pacific. In terms of market share and overall capabilities, Alibaba still ranks behind Amazon and Microsoft, but is the only Chinese cloud company to be ranked by Forrester Wave. Additionally, Alibaba Cloud does have its niche selling points as the same study also revealed that Alibaba Cloud tops all global peers in two types of services: Container-as-a-Service (CaaS) and Function-as-a-Service (FaaS).

Forrester Wave's FaaS Rankings

Forrester Wave’s FaaS Rankings (Forrester Wave)

Besides providing Alibaba Cloud with a USP, its leadership in serverless cloud through FaaS and CaaS will be attractive to users in SEA as they are on the lower end of the pricing spectrum when compared to the other suite of cloud services such as IaaS. Since SEA has lower spending power than Europe or even China, this would be a tailwind for Alibaba’s cloud expansion in the region.

Additionally, as FaaS and CaaS surrenders more use cases to be managed by the cloud serviced provider, this creates a sticker consumer base as switching costs are increased.

To back the strong quality of Alibaba Cloud, growth in SEA has been stellar, with revenue growth at 60% y-o-y and an increasing market share from 3.7% in 2016 to 9.5% in 2020. With the strong product line up on offer, I expect this growth to steadily continue.

Finally, unlike in Europe where Alibaba might face pressures over data security due to its Chinese origins, SEA is a much more friendlier region to Chinese tech as China has a strong diplomatic presence in the region and has invested heavily into many developing nations. The map below ranks the world by their diplomatic agreements with China and SEA can be seen in dark brown which represented one of the stronger types of ties.

China's Global Partnerships

China’s Global Partnerships (Newsweek)

Another region of expansion would be Africa & the Middle East which also has closer ties with China. To enter these region, strategic partnerships are important and Alibaba has shown to be prudent in their decision marking. For example, they will be opening 2 new data centers in Saudi Arabia, with a $500 million investment commitment over the next five years. This JV includes the Saudi Company for Artificial Intelligence (SCAI), which is wholly owned by the country’s Public Investment Fund (PIF), signaling governmental support for their entrance.

Hence, as the cloud segment turns profitable, I believe that it will still remain a strong revenue growth driver both domestically and internationally for Alibaba — and as all this expansion further adds to its scale, margin improvements will definitely be beneficial to shareholders.

Thesis 3: Alibaba Is Well Positioned To Benefit From An Improving Regulatory Outlook And Economy

Finally, this would be a relatively shorter thesis as I wish to quickly address the regulatory developments in China. Many of us should know that in recent weeks, the Chinese regulators have expressed that the tech-clampdown in China would be coming to an end. On Tuesday, the State Anti-Monopoly Bureau stated that it had achieved strong outcomes in controlling monopolistic practices and are now focus on restoring market confidence. Top CCP officials had also met with big tech leaders back in May to reaffirm support for the healthy development of the platform economy and to reassure that new regulations would be predictable moving forward.

This is extremely important for Alibaba as they are arguably the firm worst hit by the anti-monopolistic clampdown over the past two years, paying the bulk of antitrust fines. With an ending tech-clampdown and governmental support for economic growth, we could see Alibaba being able to continue to grow and innovate in areas which were put on hold during the clampdown such as Ant Financial. As mentioned in my previous article, economic stimulus would also benefit Alibaba greatly as they are a primarily consumption based company, in an economy that is driven by consumption. Hence, as China aims to boost its economy post pandemic through lifting digital platforms and stimulus, Alibaba will be one of the greatest benefactors of both. To read more on why Alibaba will be at the forefront of the regulatory and macro-environmental recovery of China, you can read my previous article: Alibaba And Baidu: At The Forefront Of Chinese Stocks Recovery

Valuation

Finally, I have updated by SOTP valuation for Alibaba with FY22 figures. Assumptions for my multiples, exchange rates and individual valuations remain constant with my previous articles and are still on a more conservative end.

Alibaba Updates SOTP June 2022

Alibaba Updates SOTP June 2022 (Author’s calculations)

I obtain a fair value range of $224 to $254, which is a 105-130% upside from a closing price of $110.

Conclusion

In all, my stance on Alibaba remains the same as one year ago – the company remains a resounding buy, both from a fundamental and valuation standpoint. In fact, Alibaba today is in a much stronger position than before considering that regulatory clampdowns are ending and that the company has started to turn a profit in their cloud division. Finally, beyond e-commerce growth in China & Southeast Asia, Alibaba also has an under appreciated growth driver in new retail which will be value accretive for the company and shareholders in the long run. It is now a good time to buy a fundamentally strong company still trading at a steep discount as share price recovery is right on the horizon.

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