Alibaba: China Remains Uninvestable (NYSE:BABA)

In recent years, Alibaba Group Holding Limited (NYSE:BABA) has struggled to create meaningful shareholder value as the deterioration of the Sino-American relations along with the CCP’s strengthening of grip over the Chinese private sector created numerous external and internal challenges that negatively affected the company’s underlying business. Considering that Sino-American relations are not improving, the political risks within China remain high, and Alibaba’s revenues are no longer growing at a double-digit rate, I continue to believe that it’s not worth investing in the company or into any other Chinese business as the upside appears to be limited.

No Reasons For Optimism?

Back in March, I wrote an article on Alibaba in which I called the company ‘dead money’ due to the lack of any meaningful growth catalysts that could’ve helped the business to recover from the CCP’s crackdown that started in late 2020 and resulted in the destruction of over $1 trillion in value. Since the publication of that article, Alibaba’s shares have slightly appreciated but failed to gain momentum as there are still no major growth catalysts that could’ve improved the overall situation and created a meaningful shareholder value along the way.

The Q4 earnings report that was released last month also didn’t give a lot of reasons to be optimistic about the future. While the company managed to increase its revenues by 7% Y/Y to $30.73 billion and beat the estimates by $310 million, the bottom-line performance was disappointing as net income decreased by 96% Y/Y to $127 million.

At the same time, despite the revenue beat, Alibaba is slowly losing its dominant position in the Chinese eCommerce market to newcomers who are disrupting digital sales in the mainland. If we look closely at Alibaba’s revenues by segment, we’ll see that its Taobao and Tmall Group revenues in Q4 were $12.91 billion, while its international digital commerce business generated $3.80 billion. For comparison, PDD Holdings Inc. (PDD) which launched its eCommerce apps Pinduoduo and Temu in recent years, managed to grow its revenues in the recent quarter by 131% Y/Y to $12.02 billion. This is only slightly below Alibaba’s revenues and at the current growth rate, there’s a possibility that Alibaba’s eCommerce platforms will lose its dominant position in China and abroad soon as the lack of major growth catalysts makes it almost impossible to significantly improve the underlying business. I believe that that’s one of the main reasons why Alibaba’s shares have underperformed against PDD in the last year as investors are slowly losing hope.

What’s more, is that it also looks like Alibaba’s cloud business which in the past could’ve been considered as the company’s future major driver of growth is also performing worse in comparison to its international peers. In Q4, Alibaba’s cloud intelligence business increased its revenues only by 3% Y/Y to $3.55 billion. After the U.S. chip export restrictions negatively affected the business, it’s hard to see how it’s supposed to grow at an aggressive rate in the current environment and mitigate the downside from the relatively weak growth of the core eCommerce business.

On top of all of that, China itself is losing the confidence of international investors, which also negatively affects Alibaba. The ongoing property crisis in China and the continuous strengthening of grip over the private sector by the CCP have already resulted in the record outflow of capital from China, while the worsening of the Sino-American relations is likely to result in further outflow of funds and make the China uninvestable to foreigners for now.

All of this suggests that Alibaba has limited growth catalysts and its business is unlikely to fully recover anytime soon from the CCP-led crackdown that started a few years ago. The street already expects Alibaba’s earnings to decline this year, while its revenues are likely to grow only at a single-digit rate in the foreseeable future.

Is This A Value Trap?

Given all of those developments, I decided to make a DCF model to figure out what is Alibaba’s fair value in the current environment. The revenue growth assumptions are mostly in-line with the overall consensus which suggests that Alibaba will be growing at a single-digit rate in the following years. The EBIT assumptions in the model for the following years closely correlate with Alibaba’s historical performance.

The tax rate in the model for the projection period stands at 21%. While the 21% rate is higher in comparison to the rate in FY24, it’s nevertheless lower than it was a few years ago and lower than the current Chinese corporate rate of 25%. Considering that in the past there were already cases when Alibaba’s businesses lost their preferential tax statuses due to the stronger political interference in the private sector, it makes sense to assume that the tax rate in the following years could be higher than in FY24.

The assumptions for all the other metrics in the model closely correlate with Alibaba’s historical performance. The WACC in the model is 8%, which is almost in line with the market’s average cost of capital rate, while the terminal growth rate in the model stands at 3%.

Even if some of the assumptions in the model could be considered too conservative by some people, my model nevertheless shows that Alibaba’s fair value is $115.39 per share, which represents an upside of ~50% from the current market price. My calculations are also slightly above the current consensus price target of ~$105 per share.

Considering that Alibaba trades at less than 10 times its forward earnings, which is below the industry’s median and the broader market average, it makes sense to assume that the company is undervalued based solely on the fundamentals. Despite this, I decided not to give Alibaba a BUY rating.

The biggest issue with Alibaba is that for years the company has been undervalued, and yet its shares continued to depreciate and underperform against its American peers. The first chart below shows that the company had a lower P/E in recent months in comparison to companies like Microsoft Corporation (MSFT), Amazon.com, Inc. (AMZN), and Alphabet Inc. (GOOG), (GOOGL) all of which have exposure to the cloud market and in one way or another are exposed to the eCommerce field just like Alibaba.

The second chart below shows that for years Alibaba has been trading at less than two times its sales, which is greatly below its American competitors.

However, if we look at the performance of Alibaba’s shares in comparison to the same peers, we’ll see that the company has been greatly underperforming and failing to create meaningful shareholder value.

This makes me believe that Alibaba at this stage is nothing more than a value trap. While its fundamentals are solid, its business is growing only at a single-digit rate in comparison to the double-digit growth rate at which its international competitors are growing. At the same time, Alibaba now also faces greater pressure from domestic peers that slowly disrupting the Chinese eCommerce industry. On top of all of that, the rise of geopolitical risks and the outflow of capital from China makes it even harder to justify a long position in the company even at the current price. While its American peers trade at higher multiples and could even be considered overvalued by some people, they nevertheless appear to have more than enough growth catalysts to retain their momentum, grow their businesses at an aggressive rate, and create additional shareholder value along the way. The same can’t be said about Alibaba at this stage.

The Bottom Line

Despite being fundamentally undervalued, it’s hard to justify opening a long position in Alibaba even at the current price. Seeking Alpha’s Quant system perfectly illustrates Alibaba’s current state of affairs. While its shares are not overvalued in comparison to others, the relatively weak momentum and the lack of growth are preventing giving Alibaba a rating of BUY.

Add to all of this the fact that the lack of growth and momentum at large is caused by the political and geopolitical issues that were described earlier in this article, and it becomes obvious that Alibaba and the rest of the Chinese stocks could be considered uninvestable at this stage.

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.