The culprits behind Alibaba’s continued August decline in shares were an report that fell short of expectations for the top line, and continued, escalating regulatory aggression against the Chinese Internet giant.
In early August, Alibaba reported quarterly that beat expectations but fell short of expectations. With such low sentiment, the mixed results were probably enough to worry investors that regulations are starting to affect the company’s financial performance.
Previously, Alibaba had used its first-mover advantage to squeeze out competitors, often forcing brands into exclusive contracts to gain access to its market-leading e-commerce platform. But in April, the company was fined $2.8 billion for violating antitrust rules and was ordered to stop the practice. Ending forced exclusivity could strengthen upwardly mobile e-commerce challengers, so the fact that Alibaba’s revenues came in slightly below expectations is not a good sign.
The situation didn’t get any easier as the month progressed. In mid-August, the State Market Regulation Administration issued a comprehensive list of rules prohibiting tech giants from illegally collecting and using customer data or using technology to deny access to competitors’ products. As one of the largest and most powerful “legacy” technology platforms in China,
Alibaba is likely to lose more than its competitors as the rules are designed to level the playing field. The Ministry of Transportation has also begun work on rules to ensure the welfare of delivery drivers, which could affect the cost of food delivery for Alibaba subsidiaries Ele.me and Freshippo.
A series of new rules will undoubtedly hit Alibaba’s financial performance. But it doesn’t look like the company will disappear anytime soon. After all, last quarter the company’s revenue was up 34%, though, minus the effect of Alibaba Sun Art’s retail consolidation, it was only 22%.
After such a brutal collapse, the company’s stock looks cheap: it’s trading at about 17.9 times this year’s projected — and that’s with a significant net cash position and tens of billions in minority investments in other companies. Alibaba stock had already attracted prominent value investors Charlie Munger and Bill Miller earlier this year, and now its value has dropped significantly.
Thus, Alibaba could be a good deal for patient investors if they can pay attention to the key factors. And here are three factors supporting Alibaba.
1. Dominating business in China
According to Goldman Sachs, Alibaba dominates the e-commerce market with a 69% share by 2020, making it the Chinese Amazon. Alibaba has 912 million active customers in China and 1.17 billion worldwide. In 2020, the company will have a gross market size of $1.2 trillion, representing the value of all transactions flowing through Alibaba’s business.
Alibaba also owns a 33% stake in Ant Group, a major payment company in China that operates Alipay, which handles more than half of third-party payments in China. In other words, Alibaba is relevant to many aspects of the Chinese consumer and their economic activity.
2. Fantastic financial performance
In 2020, Alibaba’s revenue grew 41% to $109 billion, aided by consumers using online services during the pandemic. In the first quarter of 2021 (ending in June), the company saw rapid revenue growth of nearly $32 billion, 34% more than in 2020. Alibaba is expected to generate $143 billion in revenue by the end of the year, a 30% increase.
The company is also very profitable. It converted $3.2 billion of first-quarter revenue into free cash flow and now has $72 billion in cash, cash equivalents, and short-term investments on its . This gives Alibaba tremendous financial flexibility to create/develop new business segments or acquire emerging competitors.
3. It’s a bargain buy
Even though the company’s stock price is falling, Alibaba’s continued growth is driving the stock down. Last fall, the stock was trading at a price-to-sales ratio of nearly 8, and today it is less than 4 when using the expected full-year for 2021.
In terms of , we can use the price-to-earnings ratio to take another look at Alibaba’s valuation. The company is expected to earn $9.70 per share in 2021, resulting in a price-to-earnings (P/E) ratio of 20, which is about a third less than Amazon’s current if we use its expected 2021 per share.
Alibaba stock seems very inexpensive given its dominant position in China and its ability to grow its huge revenue by 30% – and remain profitable.
Alibaba is a unique company that offers investors growth, strong fundamentals, and an attractive valuation, but despite all these positive factors, it is risky. The company may continue to trade at a lower valuation than companies such as Amazon for a long time to come because investors can never be completely sure that political risks will not emerge in the future.
Nevertheless, Alibaba stock is like a “coil spring ,” which could unleash strong gains if investor sentiment becomes more favorable. This upside potential makes Alibaba an interesting idea for savvy investors.
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