In the world of investing, every cloud truly has a silver lining. The last pull in Alibaba Group Holding Limited’s (NYSE:father, OTCPK: BABAF) stock price offers investors an attractive opportunity to exploit a company poised for potentially accelerated growth. While the most recent fiscal second quarter earnings report presents a mixed bag of results, it is important to view this in the context of Alibaba’s strategic shift towards a more sustainable growth model. Despite temporary setbacks, Alibaba’s strong financial performance, particularly in its international retail division, paints an encouraging picture for the future.
Fiscal Q2 Earnings Analysis
Alibaba’s latest EARNINGS report presented a mixed bag of results, with the top line and adjusted EPS generally meeting expectations. However, the company’s decision not to proceed with a full spinoff of Cloud Intelligence Group was largely due to US government export restrictions. of advanced computer chips and semiconductor manufacturing equipment, in our view, is likely to cause a negative response in the share price. Similarly, Freshippo’s delayed IPO plan adds to the uncertainties.
Notable positives include the performance of Alibaba International Digital Commerce Group (AIDC). This unit delivered strong annual revenue growth of 53%, up from 41% last quarter. International retail revenue surpassed this, achieving an impressive 73% year-on-year growth. AIDC’s ongoing preparations for raising external funds can further strengthen its financial performance.
Adjusted total EBITA exceeded our estimate by 9%, mainly due to better-than-expected earnings from Taobao and Tmall Group. Additionally, the company’s announcement of its first annual cash dividend distribution of USD 1 per ADS, which yields 1.1% above the current share price, is an encouraging development for investors.
On the downside, the cloud business underperformed, registering revenue growth of just 2% year-over-year—falling short of our estimate of 5% year-over-year. The decision to stop the full spinoff of Cloud Intelligence Group, mainly due to US export restrictions, complicates the future of this segment.
Taobao/Tmall’s modest annual decline in online payment GMV this quarter also raises concerns. This decline may be symptomatic of broader challenges in the e-commerce sector, or it may be specific to Alibaba’s platform. More data and subsequent quarterly results will be needed to fully understand this trend.
Insights from the Call
Alibaba Group’s earnings CALL focused on a strategic shift to a more sustainable growth model anchored in AI-driven demand for scalable and networked cloud computing services. The company opted against spinning off its Cloud Intelligence Group due to uncertainties from US export restrictions on advanced computer chips. Instead, Alibaba is betting on the growth of AI, anticipating a continued increase in demand for computing power and services of large models.
The company’s capital management plan revolves around four main areas. First, increasing the return on invested capital is a priority. Alibaba aims to grow its single-digit ROIC into double digits, indicating an emphasis on profitability and efficiency improvements. Second, Alibaba plans to invest in strategic growth opportunities highlighted by the reorganization of its business, leveraging its strong balance sheet.
Third, monetizing non-core assets is a strategic move for Alibaba. to the company BALANCE it carries $67 billion in equity securities and other investments, which are not core but strategically important. The company is exploring ways to monetize these assets and return value to shareholders. Finally, Alibaba’s commitment to returning value to shareholders is evident in its share buyback program and newly announced plans to pay an annual dividend.
Alibaba’s Cloud Intelligence Group is at the forefront of the company’s growth strategy. This strategy depends on AI and public cloud prioritization. The group plans to invest aggressively in AI-related software and hardware, symbolizing a shift from traditional computing to AI. Alibaba envisions most AI computing to run in the cloud in the future and is positioning itself as a leading provider of sustainable and efficient AI infrastructure across industries.
The company is also creating an open and prosperous AI ecosystem. This was demonstrated by his recent announcement at the Apsara conference of a comprehensive upgrade to its AI infrastructure. Alibaba is actively managing the quality of its cloud revenue to increase profitability. It plans to reduce project-based revenue exposure, invest more in core products for public cloud, and improve the quality of cloud business revenue by focusing on public cloud.
Financial and Valuation
Note: All historical data in this section comes from the company SEC filingsand all consensus numbers come from FactSet.
Looking at the bigger picture, BABA’s revenue growth, at a CAGR of 20.1% over the last three fiscal years, is impressive. However, forecasts suggest a slowdown in growth, with revenue expected to rise 7.2% this fiscal year to $132.5 billion and 9.8% next year to $145.5 billion. The EBIT margin, which decreased by 6.4% in the last three fiscal years, from 18.0% to 11.6%, is expected to expand by 371 basis points this fiscal year to 15.3% and by 7 basis points next fiscal year to 15.4%.
We see a positive trend in the dynamics of the company’s shares. Over the past three years, BABA spent 4.4% of its revenue on stock-based compensation. Meanwhile, common shares outstanding decreased by 6.4%, suggesting a strategic use of share repurchases to offset shareholder dilution. However, this strategy has not significantly fueled EPS growth, which grew at a CAGR of just 1.5% over the last 3 fiscal years, lagging behind its revenue growth. Consensus forecasts EPS to rise 15.8% to $8.99 this fiscal year and 4.5% to $9.40 next fiscal year.
Projected free cash flow (“FCF”) for the current fiscal year is $22,194 million, an FCF margin of 16.7%, which is down from four fiscal years ago when it was $21,137 million, a 29.6% FCF margin. Considering the average FCF margin of 21.5% over the last four completed fiscal years, this appears to be a downward trend which is cause for concern. On the other hand, capital expenditure as a percentage of revenue averaged 7.3% in the same period, suggesting that the business has a relatively high capital intensity.
Alibaba’s balance sheet looks healthy, with net cash of $48,843 million. Now that Alibaba is paying a dividend, the stock should appeal to income-focused investors.
Looking at its valuation in 2024 estimates, BABA is trading at an EV/Sales multiple of 1.0, an EV/EBIT multiple of 6.3, a P/E multiple of 8.4 and an FCF multiple of 7.9. These valuation multiples are significantly lower than the S&P 500, suggesting the stock is undervalued.
Using the 12-month P/E metric, BABA currently trades at 9.4, which is a historically low valuation compared to its 5-year average of 19.9 and a 2-standard deviation range of 7.5 to 32.3. Compared to its peer JD, which trades at a forward 12-month P/E of 8.9, BABA appears to be relatively well valued.
In an era where the power of artificial intelligence and cloud computing is rapidly reshaping industries, Alibaba stands as a potential titan poised to emerge from the shadows. Its strategic shift towards AI-driven demand for scalable and networked cloud computing services, along with its commitment to returning value to shareholders, underscores the company’s resilience and determination to stay ahead of the curve.
Despite the recent share price pullback, Alibaba’s strong fundamentals, along with a historically low valuation relative to its 5-year moving average, make it an attractive proposition for value investors. The company’s strong balance sheet and impressive international retail sales growth, along with its focus on profitability and efficiency improvements, suggest a positive future trajectory. With its Cloud Intelligence Group at the forefront of the company’s growth strategy, Alibaba is clearly positioning itself as the leading provider of sustainable and efficient AI infrastructure across all industries.
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