Alibaba Group Holding Limited (NYSE:father)(OTCPK: BABAF) reported its latest quarterly earnings results on Thursday morning. The company beat earnings estimates and yet, the market reaction was not positive, as BABA shares fell 8%. The company also declared a dividend, although a small.
Alibaba Group Holding announced this income results for the fiscal second quarter on Thursday, before the market opened. The title numbers can be seen in the following screenshot from Searching Alpha:
We see that the company beat earnings estimates by about 2%, while the company missed the revenue consensus estimate by about 0.8%. That said, the company still delivered attractive business growth, as revenue rose 9% compared to the year-ago second quarter.
That’s, for reference, slightly less than Amazon’s (AMZN) increase in income during the most recent quarter, while AMZN grew its top line by 13% year-over-year — though it’s important to note that Amazon trades at a much higher valuation of more than 50 times forward net earnings.
Alibaba Group also noted its strong cash flows during the period. While operating cash flows increased by 4%, a reduction in BABA’s capital expenditure resulted in a significant increase in free cash flow of 27% compared to the year-ago period, which is attractive in absolute terms and which is even more attractive considering the bargain valuation. of 9x forward net earnings BABA is currently trading.
The market did not like these results as stocks fell after the release of these results. Due to a positive earnings surprise and strong cash flows, this is somewhat surprising, especially when we consider that macro pressures may ease, as the meeting between President Biden and President Xi it went wellwhich could result in the easing of tensions between the US and China.
BABA Results: Lots to like
Over the past couple of months, we’ve heard a lot about the (supposed) slowdown of the Chinese economy. Problems in the country’s real estate market had, according to many, a negative impact on consumer confidence and spending, as well as overall economic growth.
In such a climate of subpar economic growth, a 9% revenue growth rate is very attractive, I believe. Alibaba is already a very large company, so it is not easy for the company to grow at a high rate, and yet the company managed to increase its sales by almost 10% in a tough macro environment.
Even better, however, was the company’s earnings performance. While revenue growth is good, earnings growth—or, more accurately, earnings per share growth—is what ultimately decides a company’s stock value. Alibaba has been focused on improving its profitability, and with its latest quarterly earnings results, Alibaba has proven once again that it is very capable of creating shareholder value by focusing on improving margins over time.
A revenue growth rate of 9% turned into an EBITDA growth rate of 18%, as cost-cutting measures and focus on the most profitable core business lines paid off handsomely. Even better, operating profit was up 34% compared to the year-ago quarter, which is a very strong growth rate. Even many US-based tech companies, which often trade at giant valuations compared to Alibaba, aren’t growing as fast.
Alibaba is a marketplace
EBITDA came in at $5.9 billion, or about $24 billion a year, which is a pretty hefty number for a company that’s trading at an enterprise value of just $170 billion, using YChart’s numbers and adjusting for that for 8% pre-market share price. decline With an enterprise value to EBITDA ratio of 7x, BABA is a pretty cheap stock — considering the strong rate of business growth, earnings and cash flow, that doesn’t seem justified, I believe.
We can also look at other metrics to see if they also support an undervaluation thesis. Over the past four quarters, Alibaba has generated about $30 billion in free cash flow, while trading at a market capitalization of just over $200 billion (note: BABA’s market cap is higher than its enterprise value due to a net monetary position on its balance sheet). This translates to a free cash flow multiple of about 7x, which, again, is quite low. In other words, investors can buy BABA at a free cash flow yield of around 14%, with said free cash flow growing at a high rate over the last quarter.
Last but not least, BABA’s earnings multiple is also quite low, at less than 9x for the current year, and that’s not even counting the fact that BABA beat expectations for the most recent quarter, which which may indicate that the actual profit estimates for this year may be too low.
No matter how you slice it, Alibaba is a pretty cheap stock. Of course, the bears will argue that there are good reasons for this, so let’s take a look at the arguments.
– Geopolitical concerns and tensions between the US and China have been cited as reasons for BABA’s low rating. It’s true that there are tensions, but they appear to be easing — see the article on the Biden-Xi meeting linked above. It is in the best interest of both countries to allow tensions to ease further, as both countries want to see their economies grow.
– Some bears have argued that all of BABA’s cash flow isn’t creating any shareholder value, with some arguing that Chinese companies can never pay all their cash back to their shareholders. Alibaba has been buying back its common stock for some time, and now they have declared a dividend for the current year: BABA will pay $2.5 billion, or $1 for ads, in a new strategic shift towards higher direct payments to shareholders. While the dividend yield isn’t particularly high, around 1.2%, the increase in shareholder payouts suggests that BABA can indeed access its cash and that shareholders benefit from the company’s strong cash generation. Thus, I believe the bearish argument that cash flows have no value to investors has been debunked. If BABA continues to buy back shares while being able to increase dividend payments over time, shareholders would benefit greatly from the massive cash flows the company generates.
– China’s business intervention and regulation has been cited as a risk by some bears. It’s true that this is a risk, but Western tech companies face similar regulatory risks — that alone doesn’t justify an extremely low rating for BABA. I believe it is not in China’s best interest to harm its technology champions, and China has not interfered much in BABA’s operations in the recent past. While one could argue that this risk somewhat justifies a discount for BABA stock relative to Western tech players, it’s hard to argue that BABA at 9x forward net earnings is fairly valued compared to AMZN at more more than 50x net earnings. Even if BABA’s stock were to double, the company would ultimately trade at a massive discount to AMZN.
I believe Alibaba Group is an attractive company. BABA provides exposure to both e-commerce and the digital economy and China’s growing consumer market. The company delivered good business growth and excellent growth in profit and cash flow during the last quarter, and the valuation is very low.
With the company entering a new phase of shareholder returns through its first dividend announcement, investors can look forward to meaningful shareholder returns.
While BABA is not a risk-free investment, the risks seem more than accounted for at the current price, I believe — at just 7x free cash flow, BABA is rated for a disaster.
Editor’s Note: This article discusses one or more securities that are not traded on a major U.S. stock exchange. Please be aware of the risks associated with these stocks.