Alibaba Group (BABA)
Alibaba recently agreed to another smart deal, a 10% stake in Dufry, the largest duty-free retailer in the world.
Alibaba continues to show impressive revenue and earnings growth but is still reasonably valued according to those metrics.
There are risks but the stock has multiple competitive advantages especially economies of scale.
Monday brought news that Alibaba (BABA) is to buy up to a 10% stake in Swiss duty-free retailer Dufry. The deal, worth $763 million, is well timed and helps both sides.
While Dufry can benefit from Alibaba’s payment services and reach, Alibaba will benefit from access to authentic duty free products avoiding the cheap knock offs that plague Chinese retail.
Alongside Alibaba’s strong showing during the pandemic (the company set up a new platform dedicated to providing PPE) and relationship with upcoming IPO Ant Financial, this looks like another good move that will further strengthen Alibaba’s brand.
Alibaba is by some measures the largest ecommerce platform in the world with 742 million customers, up from 674 million in 2019.
Not only is Alibaba positioned to take advantage of continued global trends towards ecommerce, it has exposure to China, one of the fastest growing regions in the world.
According to Global Data, China's e-commerce market is set to grow at a CAGR of 13.3% to reach US$2.6 trillion in 2023. Alibaba, with its 60%+ majority share, is in the perfect place to profit from that growth.
Alibaba reports reasonable gross margins of 44.5% which have decreased substantially over the last eight years from over 70% in 2013. This decline is partially expected, however, as the company has invested in new ventures and matured into an $800 billion company.
As an intermediary to ecommerce and digital services, Alibaba doesn’t have the high operating costs that afflict other businesses.
Alibaba stock currently trades 2% below it’s 52-week high and is up 38% YTD. The monthly chart is significantly extended but this is not a negative factor for the long term therefore I don’t penalize it. Short float is low at 2.13% and turnover is high indicating robust demand.
At an enterprise value just under $800 billion, the chances of a 10X return in Alibaba are remote as it would imply a valuation of $8 trillion.
History, Management and Social Value
Alibaba has had an impressive few years and continues to grow both revenues and earnings at more than 30%. The company has increased revenues every year since 2010 and has increased EBITDA in 7 of the last 9 years. There aren’t many companies with such strong track records.
Management also has a history of good decision making with the latest Dufry deal another example. Moreover, the company is providing social value with efforts to tackle coronavirus and with products that are in high demand among consumers.
Alibaba currently trades at a rich multiple of 31 times earnings or 36 times EBITDA. This is an expensive multiple especially for a company of this size.
However, Alibaba has grown revenues and EBITDA at more than 40% annually over the last five years. Growth rates as shown in the table below are impressive:
Source: Seeking Alpha.
The company won’t be able to keep up that growth, forever, but for now there is still runway ahead. This level of growth puts the PEG ratio around 1 which indicates fair value.
The current multiple is also not out of place when compared with the historical average. In fact, BABA has traded at higher multiples in the past such as in 2014 when the stock traded over 45 times EBITDA.
Source: Seeking Alpha.
Just as valuation is reasonable so is the balance sheet. Long term debt sits at $33 billion which is less than annual EBITDA and the company has $71 billion in cash.
If we assume that Alibaba can grow earnings at 20% over the next five years and then trade at a similar multiple of 30 times earnings, the stock would be worth roughly $2 trillion in 2025. That would translate into a 20% annualised return on investment based on today’s prices.
The stock does drop some points here as it is only fairly valued and not ‘cheap’.
I believe qualitative factors to be crucial to a company’s returns and I like to look at important qualities such as brand, network effects, monopoly and economies of scale.
Alibaba clearly has economies of scale being the largest ecommerce operator in China which give it significant pricing power.
Alibaba also has monopolistic features with over 60% of the share of online consumer transactions in China in 2020 according to Statista.
The Alibaba reach extends to various areas such as B2B, payments and cloud which further extends its monopoly and also provides network benefits.
A glaring issue is that this is a Chinese company with all the typical risks that go alongside it. Chinese companies are known for less stringent financial reporting.
As well, the current US administration is threatening to have Chinese companies delisted.
Although this would be problematic, I like to think that I would be able to transfer my holdings to Hong Kong and not have to sell out.
In my view, a price decline following a US delisting would also be temporary and a buying opportunity. Needless to say, a Biden administration would all but eliminate this risk.
Another risk is that the Chinese government imposes anti-monopoly laws that put the squeeze on Alibaba’s market share. Such laws have been passed before such as on Qualcomm and were last talked about in financial media in January. Whether or not they would impose such laws on Alibaba I don’t know.
Alibaba is also investing heavily in future growth with significant expansions across business lines and countries. Investments overseas, in India for example, could be a significant cost burden going forward and would need careful consideration. This could well be the biggest risk for Alibaba shareholders going forward.
Overall, the company has a multitude of risks that can be read in the Risk Factors section of the latest annual filing. This is not surprising given the size and nature of the company but I generally see most of the risk as short-term. In my view, it would take a lot to alter the trajectory of Alibaba which is now entrenched in the global ecosystem.
It’s worth noting that Amazon (which bears similarities to Alibaba) trades at an enterprise value of $1.6 trillion with annual net income of $13.18 billion. Meanwhile Alibaba trades at an enterprise value of $762 billion with almost double the net income ($24.8 billion).
Not only does Alibaba have stronger margins and net income than Amazon, it also operates with less competition in a region with more potential for growth. That said, Amazon has significantly higher revenues and a thriving cloud business.
I like both companies but Alibaba has a better valuation. I already own a full position and I am adding some more today.
Disclosure: long BABA.
This post expresses the opinions of the writer and is for information, entertainment purposes only. Joe Marwood is not a registered financial advisor or certified analyst. The reader agrees to assume all risk resulting from the application of any of the information provided.
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