Why Alibaba's (NYSE:BABA) Risk is Separate From the Fundamental Potential of the Company

By
Goran Damchevski
Published
May 31, 2022
NYSE:BABA
Source: Shutterstock

Key takeaways:

  • Alibaba underperformed in the last 12 moths, but investors are hopeful on an economic recovery in China.
  • The company's valuation is mixed, as the price target and our DCF indicate upside, but the PE shows exposure relative to the industry.
  • Alibaba may recover and be a great company, but it is currently a high-risk investment until the US and China settle the audit question.

Alibaba Group Holding Limited (NYSE:BABA) released its annual results and investors reacted positively with the stock increasing 7%. In this analysis, we will review the attractive aspects and risks of Alibaba for investors.

Starting from the latest earnings, we note these key highlights from their report:

  • Full Year:
    • Revenues of CN¥853b - in line with estimates.
    • Net income of CN¥61.9 and EPS of CN¥22.74 - missed expectations by a major 25%.
  • Last Quarter:
    • Revenues of CN¥204,1b vs CN¥187,4b a year ago, an 8.9% growth
    • Net loss was CN¥16,1b vs CN¥5,4b a year ago

While the full year results came in profitable, the company struggled in the last quarter.

The company had difficulties operating in the homeland among the tech crackdown and the Zero COVID policy. However, the lockdowns have been a mixed bag for Alibaba, as it experiences a larger order volume, but significant bottlenecks in delivery.

The chart below illustrates the reduction of expected growth for 2023 by analysts. Following the earnings, analysts now estimate that the company will grow revenues at an annual rate of 9.6%, and earnings at 18.7%.

Profitability is expected to stabilize and pick up after 2023, as the economy opens up and companies settle the playbook with the government.

Check out our latest analysis for Alibaba Group Holding

earnings-and-revenue-growth
NYSE:BABA Earnings and Revenue Growth May 30th 2022

Value and Risks

Analysts still see some 65% upside, as the average price target is remains at US$154. Alternatively, our discounted valuation model indicates that the stock may be 20% undervalued, based on the cash flow projections for the company. Taken together, investors may find that the stock is somewhat undervalued based on the fundamentals.

However, there are two key things to note:

First, our DCF model is made from estimates and some assumptions that may not be the best fit for Alibaba - so, take it with some caution. Additionally, the company has a PE of 27x while companies in the same industry are trading at a 14x PE, so the company's pricing may be unsatisfactory to investors unless in convinces them that it can increase profitability.

Second, even though a model estimates fundamental upside, this does not take into account the discrete risks that Alibaba is exposed to. Of those, there is the ongoing government pressure on tech companies - which seeks to establish a firmer control into the operations of this and other companies. Next, is the increasing tension between the US and China regarding access for auditors to Chinese ADRs. Both of these can result in fast and significant changes to the investment potential of the company, which is partly the reason why international investors have been conservative with Alibaba and other Chinese companies for the past year.

Investors, that manage to predict how the situation will pan out, stand to gain a lot with Alibaba - but this necessarily implies that the company is currently a high risk investment.

Conclusion

Alibaba underperformed, mostly because of the current situation in China, but may recover if they find common ground with the government and the pandemic stops being a threat. A portion of Chinese consumers that were subject to lockdowns have made some savings, which may flow into Alibaba as restrictions loosen up.

The company also has a significant discrete risk for international investors, and while analysts expect the US and China to reach an agreement regarding auditing ADRs, the situation can change on a whim, which makes Alibaba a high-risk investment.

We've also identified 3 fundamental warning signs with Alibaba Group Holding, and understanding them should be part of your investment process.

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.

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