Alibaba Smashes Earnings: My Final Thoughts (Rating Downgrade)

Alibaba Group Holding Limited (NYSE:BABA, OTCPK:BABAF) just released its December quarter earnings (fiscal third quarter) and easily surpassed all expectations. The release slightly beat analyst expectations on revenue and handily beat on earnings. Heading into the release, Alibaba faced a number of headwinds, including falling retail sales, renewed U.S.-China tensions, and a chaotic end to China’s Zero COVID policy. Between all the different risks and perceived risks, sentiment toward BABA dimmed in the days leading up to the release. As we saw in the actual release, the risks that people perceived were overblown.

Heading into Alibaba’s earnings release, I was expecting pretty good results. When I looked at analysts’ earnings expectations, I noticed that they weren’t very high. For example, the expectation was for a 5.6% revenue decline for the whole quarter, even though only one month in the quarter saw Chinese retail sales fall that much. What we actually got was a small, positive increase in constant currency revenue.

Alibaba stock has given investors a wild ride these last few years. Since reaching a high of $310, it has fallen some 66%. This year, BABA stock has been on an upward trajectory, albeit a rocky one with some bumps in the road. With the December quarter earnings finally out, things are looking good. Earnings are rising, free cash flow is high and China is expecting solid economic growth in the year ahead.

Given the return of stability to the Chinese market, I’m planning on slowing down my coverage of Alibaba stock this year. I wrote about it extensively in the past, such as here and before that here, when risks were running high and investors needed to make sense of what was happening in a frightening landscape. Today, the situation looks far less dangerous, and investors don’t have as many risks to think about. In this article, I will explain why I’m still bullish on Alibaba after its December quarter earnings release, and offer my “final thoughts” before taking a break from covering the stock.

Earnings Recap

Alibaba’s December quarter earnings release was a big beat. Some highlight metrics included:

• $35.9 billion in revenue, up 2% in constant currency.

• $5.08 billion in operating income, up 396%.

• $7.2 billion in net income, up 12%.

• $2.79 in diluted EPS, up 14%.

• $11.88 billion in free cash flow, up 15%.

It was a pretty strong showing. The highlight of the release was the free cash flow, which at $11.88 billion, was far higher than what was observed in the same quarter a year before. Some segment metrics also merit being mentioned. The Cloud segment did $3.8 billion in revenue, up 3%, and $52 million in EBIT, up 165%.

Competition in e-commerce is heating up, especially in China, so it’s good to see Alibaba putting out EBIT profits in the cloud segment. The company should benefit from having a successful non-core business, much like Amazon.com, Inc. (AMZN) benefitted after it launched Amazon Web Services (“AWS”). So, there are good signs in Alibaba’s segment results as well as its “big picture” metrics.

Valuation

Armed with Alibaba’s most recent earnings, we can now proceed to a valuation. Alibaba’s revenue, earnings and free cash flow per share for the previous three quarters were:

• Revenue per share: $34.56.

• Adjusted earnings per share: $3.73.

• Free cash flow per share: $2.23.

In the quarter just reported, we got:

• Revenue per share: $13.55

• Earnings per share $2.79:

• Free cash flow per share: $4.48.

So, our new trailing 12 month (“TTM”) per share figures are:

• Revenue per share: $48.11

• Earnings per share: $6.52.

• Free cash flow per share. $6.71

From this we get:

• A 14.5 P/E ratio.

• A 1.97 price/sales ratio.

• A 14.12 price/FCF ratio.

These are pretty low multiples, suggesting that Alibaba stock is fairly cheap at today’s prices. Discounted cash flow ("DCF") models yield similar results. In past articles, I’ve done DCF models on Alibaba with growth projections and found that BABA could be worth over $200 if you assume just a modest amount of growth. You can check this article for an example of such a model. After selling off 66% from its highs, BABA does not need much growth in order to be worth far more than what it trades for now. In fact, if you assume 0% growth and discount the trailing 12 month FCF at the current 10 year treasury yield (3.95%), you get a $169 price target. That’s a pretty decent terminal value, above today’s stock price, and you don’t need to assume any growth to produce that number.

Competitive Landscape

As we’ve seen, Alibaba put out a strong earnings release despite its stock being very cheap and beaten-down. It all looks good so far. However, there is a big risk factor we need to explore before we can really say this analysis is complete:

The competitive landscape.

Alibaba operates in the increasingly competitive e-commerce industry. Many companies have entered this industry in the last decade, a fact that Charlie Munger alluded to when he said that the industry “won’t be a cakewalk” for its participants. Some examples of these new entrants include:

• Shopify (SHOP) - an e-commerce platform company.

• PDD Holdings (PDD) - a Chinese “deep discount” retailer whose Temu app is getting popular in the United States.

• ContextLogic (WISH), another popular platform for deeply discounted goods.

Basically, there is no shortage of new e-commerce companies out there. Which is a real risk, or at least a challenge, for Alibaba. The more companies enter a space, the more they tend to compete with each other on price points. If a market gets saturated with competitors it can get to the point where no profit is possible!

In China, Alibaba’s biggest competitors are PDD and JD.com (JD). These companies sell goods similar to those Alibaba offers. If you’ve ever used Temu and AliExpress side by side, you’ll no doubt have noticed the similarity between them. Right now, there aren’t that many major competitors in Chinese e-commerce, but Pinduoduo is growing rapidly, which could eat into Alibaba’s action. So, increasing competition is a risk worth paying attention to.

Other Risks

In addition to competition, there are other risks that investors should be aware of when taking positions in Alibaba. In my opinion, these risks are less serious than the one I described in the previous section, but they are worth mentioning. Some of the most obvious include:

• U.S./China tensions. There are many issues that the U.S. and China don’t see eye to eye on. One is Taiwan. China considers Taiwan part of its territory, the U.S. unofficially considers Taiwan an independent nation, and is aligned with it militarily. China has been doing military exercises near Taiwan lately, stoking fears that the disagreements between the U.S. and China on Taiwan could turn into an actual war. Some U.S. military officials have said that they think it will happen in 2027. As of right now, nobody knows whether China will actually invade Taiwan. The country’s official stance is that it “reserves the right” to use force but will seek unification peacefully. This topic is a big question mark, and it could have bearing on non-Chinese investors’ holdings in Chinese stocks. When Russia invaded Ukraine, many brokers stopped supporting Russian stocks, and Russia itself cancelled dividend payments. Sometimes conflicts can cause trade flows (including capital flows) to stop, so a war between the U.S. and China would be risky to Alibaba shareholders.

• Regulatory risk. Alibaba has occasionally taken some hits due to regulatory measures enacted by China’s government. The best known example would be the time it took a $2.8 billion anti-monopoly fine in 2021. Since last year, not many of these regulatory issues have been seen. However, they could in principle emerge again.

The Bottom Line

Having looked at the various risks and opportunities facing Alibaba Group Holding Limited investors, we can conclude that BABA is a very cheap stock, relative to the company’s future potential. The last few years have seen BABA’s growth slowdown, which has taken a bite out of the company’s market cap. But today, at just $95 (yesterday’s close), it’s so cheap that it doesn’t need all that much growth to be worth it. Even if BABA never re-takes its previous record of high double digit revenue growth, it could perform pretty well.

It’s on that note, that I’ll conclude my coverage of Alibaba. After more than a year of covering the stock, I’ve seen plenty of ups and downs, good quarters and bad ones, big rallies and huge drawdowns. At this point, I feel like Alibaba has successfully overcome most of the risks it has been exposed to over the years, and has proven itself to be a stable and resilient company. When China’s tech crackdown was at its height, this stock deserved repeat coverage, because the situation was changing minute by minute, and the news often looked dire. Today, the situation in China is much calmer, and there is less to say about Alibaba compared to in the past.

Based on Alibaba Group Holding Limited last quarter’s earnings, it looks like things are going pretty well for China’s beleaguered e-commerce giant. Alibaba Group Holding Limited remains a big opportunity, and most investors now know where they stand on it.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.