Undervalued and Risky - Why Alibaba's (NYSE:BABA) Situation is Getting more Complicated

Summary:

• BABA price targets indicate a possible 30%+ upside, with high disagreement amongst analysts.
• The situation with the company doesn't seem to be getting better yet, and investors are faced with a mix of discrete risks that are hard to evaluate.
• The forward PE indicates that BABA is trading close to the fundamentals, and investors have opted-out of incorporating the risks into their valuation.

Alibaba Group Holding Limited (NYSE:BABA) just released the latest earnings report for the quarter ending on June 30th, showing a noticeable business slowdown based on decreased commerce activity in China. In this analysis, we will pair the risk factors for Alibaba with the fundamentals in order to see if the market is skewed in any direction.

Investors seem somewhat split on the company, as one side points out why the company is not suitable for western investors, while others turn to the fundamentals as a case why the company is undervalued by the market.

Kicking off with the latest earnings report, the key highlights are:

• Quarterly revenue of $30.7b, close to analysts' estimates.
• A beat on the adjusted EPS at $1.75 vs the estimated $1.53. With EPS at $1.27.
• Net income decreased by 50% YoY to $3.395b.
• Non-GAAP Free Cash Flow $3.310b - keep in mind the large outflow of cash from investing activities ($4.122b) which some investors may consider a better representation of CapEx.

Why Discrete Risk Matters for Alibaba

There are two main types of risk for any company: discrete and continuous. While continuous is somewhat measured by valuation models, discrete risk is something that happens as a one-time event and changes a company's future.

In the case of Alibaba, the largest concern is regarding an array of discrete risks, starting from the domestic policy of China towards tech companies, the incompatible leadership of Alibaba with the government, the official possibility of Alibaba being delisted, and the latest "show of force" escalation between the U.S. and China.

Despite all these happenings, some investors cite the fundamentals of Alibaba as an exploitable possibility, while others are reluctant to engage with the uncertainty. While we can't predict the discrete risk outcomes, we can observe that the situation is not de-escalating. When it comes to risk, in finance there is a saying "gradually, then suddenly", which may give insight why some investors are holding back on the company, as we are likely in the gradual phase. On the other hand, investors like Howard Marks, are exploring bullish possibilities in the Asian market (not BABA per se) precisely because the consensus is reluctant - however he and his team are known to be rigorous in their due diligence before investing, so they won't invest "just" because everyone is afraid.

As long as the internal and geopolitical situation surrounding Alibaba is not settled, investors will have to find a way to navigate a type of uncertainty that is hard to measure. This takes Alibaba from the large-cap growth company category to a higher risk category for investors.

Next, we will explore the fundamentals, and see how the possible upside for the company in a stabilized environment.

Is Alibaba Undervalued?

Investors suggest that the company is undervalued, while analysts have a hard time agreeing on price targets. When we look at Alibaba's 1-year price targets, we see that they have slowly drifted down, but the spread of estimates remains high:

See our latest analysis for Alibaba Group Holding

The average price target is centered on $155.45, implying some 38% upside. However, when we turn to the spread, we see that the most pessimistic analyst gave Alibaba a price target of $115, while the most bullish analyst set a target at $229 per share. This divergence of estimates prompts us to move to the relative market valuation of the company.

When we look at the price to earnings of the company, we get a value of 27.6x, fairly ahead of the industry average of 17.6x. The good news is that when we look at the earnings estimates for 2023, the company's forward PE drops to 18.2x which is much closer to the industry average. Given all of this, we can see that the company is trading fairly close to the industry averages on a relative basis, and indicates that investors are pricing the company based on near-term performance. 

The Bottom Line

Investors are following the trend of price targets, while analysts have a hard time closing the spread of targets. This reflects the growing uncertainty around the company, however it does not reflect the risk of the company as that is hard to measure. 

The discrete risk factors can't be easily paired with the fundamentals, but are present in the company nonetheless, which puts investors into a tougher situation where they need to keep in-mind both the possibility of a value gain as well as a full delisting from the U.S. which may be used as a political move in case of further international escalations.

Additionally, we've identified 2 warning signs with Alibaba Group Holding, and understanding these should be part of your investment process.

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Simply Wall St analyst Goran Damchevski and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.