Stockwatch: A top-class rival to Amazon

Soaring results from this tech giant defy fears for China's economy and make the shares a buy.

Amid the US/China trade dispute and Hong Kong unrest close to military intervention, it's brought two US-listed Goliaths of Chinese business into focus just as they report second quarter results.

Both the online retailer Alibaba (NYSE:BABA) and the conglomerate Tencent (SEHK:700) are each capitalised at around $420 billion (£346 billion) with Alibaba currently entertaining a Hong Kong listing after initially floating on the New York Stock Exchange in September 2014.

Quelling Hong Kong unrest could become a major financial event

Both these stocks are down about 10% since May when US/China trade tensions flared and more recently the pro democracy demonstrations tipped to violence.  The protests have gathered momentum such that a fanatical commitment has taken over, and I doubt unrest will be quelled without Beijing's intervention: the Chinese Ambassador in London was warming British politicians up for that, in his words yesterday. 

I suspect Beijing is in a genuine dilemma: economically, wanting to sustain international investors' confidence in Hong Kong; but politically, aware the unrest will fester the longer it continues and could spread to the Chinese mainland.  So, a case whether "infiltration by police" or direct military action is the lesser evil, will be front of mind.

If troops go in, the consequences are highly unpredictable and could worsen not only trade negotiations with the US, but add to a list of woes worrying investors (e.g. recessionary signs including an inverted yield curve) and trigger a further sell-off in equities.

Stocks such as Alibaba and Tencent could bear the brunt, but I think they do offer international investors exposure to long-term development of the world's biggest consumer market, hence a useful buying opportunity to take shape.  This has been underlined especially by Alibaba yesterday declaring much better than expected, second quarter results.

Both companies' revenues derive substantially from domestic China, where mid-week data revealed 4.8% industrial growth for July – the worst rate since February 2002 – which was below consensus for 6.0%.  Retail sales in this the world's most populous nation grew 7.6% in July, down from 9.8% in June.

Earlier this week, global stocks took heart from the US seemingly pulling its punches - deferring fresh 10% tariffs on Chinese goods to December from September – but the selling rout worsened on Wednesday as China's Ministry of Finance declared the tariffs as "seriously violating the consensus" with the US, reached at June's G20 meeting, and promised countermeasures.

Source: Company REFS

Stunning momentum for a circa $430 billion company

In such a macro context it underlined Alibaba's marketing strengths where a 42% jump in like-for-like revenue beat expectations.  Net income soared 150% and EPS 146%, beating expectations by 22%.  The stock initially rose 5% before easing to 3% at $167 by Thursday's close.  Cash conversion of operating profit remains impressive.

When drawing attention to its New York Stock Exchange flotation nearly five years ago (priced at $68 with initial dealings in a low $90 area) I suggested "this stock should be a traders' delight: buyers may enjoy further upside on a 3 to 5-year view; but is a magnificent short if China's economy deteriorates."

Downside risk may however nowadays be limited by Alibaba's sheer scale in e-commerce, having grown annual revenue by 40-70% in recent years – from $4.2 billion equivalent in 2014 to $56.2 billion in its last financial year to end-March 2019.  Its number of annual active consumers is up 3.1% in the second quarter alone to 674 million, and reach to their mobile devices is up 4.7% to 755 million.

From an international investor perspective you therefore have Alibaba on an historic price/earnings ratio in a mid 40x region, or roughly mid 30x on a 12-months forward basis (while currently proving it can beat expectations) versus Amazon (NASDAQ:AMZN) on an historic PE in the mid 70x and operating in the demographically mature US.  

But Alibaba offers exposure to the world's most populous nation with a burgeoning middle class – more likely the future for growth in consumerism.

Amazon has struggled in China for over a decade, seeing its market share fall from about 15% to 6% before it curtailed operations just recently; eBay having similarly withdrawn, leaving Alibaba and JD.com (NASDAQ:JD) to enjoy about 75% of Chinese consumer e-commerce.

Independent analysis has shown the US retailers falling short both operationally and with their marketing, rather than being hampered by government protectionism, i.e. no obstacles for trade negotiations to blow apart.  It leaves Alibaba in an enviably strong position.

Cross-selling within Alibaba's ecosystem

Management says it has driven up consumers' purchase frequency and category, also benefiting from China's continued urbanisation and growth in its middle class – trends I suggest are long-term despite near-term risks to the economy.  

Domestic competition still needs watching e.g. Pinduoduo in under-developed areas of China and J.D.com selling branded products.

20 year-old Alibaba continues its diversification and development apace e.g. expanding its Freshippo grocery chain and recently paying $2 billion equivalent for a shopping site.  

Its international side has doubled year-on-year order growth in southeast Asia for the third consecutive quarter.  

"With strong cash flow from our core commerce business, we will continue to invest in technology and bring digital transformation to millions of businesses globally."

End-June cash was $30.9 billion equivalent, up 10% on end-March, making it curious why Alibaba is considering a secondary listing in Hong Kong to raise a targeted US$10-20 billion equivalent.

Analyst comment suggests this move will help diversify the group's ownership structure and the CEO of the Hong Kong Stock Exchange has suggested more Chinese companies listed abroad will "come home" this way.  That would enable domestic Chinese investors to own stock where currently the government does not allow them to own what's US-listed. 

This underlines why Beijing needs to tread carefully in its dealings with Hong Kong; but I suspect that if tensions on both sides are splitting the "one country, two systems" approach then ultimately if Hong Kong withers as an international centre then such companies could anyway list in Shanghai or Shenzhen.

So I'd favour Alibaba over Tencent.

Tencent is interesting to watch by way of informing us about the Chinese economy. 

Yesterday, its stock initially eased about 3% but closed with a slight rise around $42, after a 21% rise in revenue missed estimates, but net profit jumped 35% - well ahead of consensus.  

Its progress is being driven by commercial payment services, smartphone games and other digital content.  Being a highly diversified group means more chance cyclicality e.g. a caution over its advertising side.

So from an investment view, I incline more towards Alibaba as a slick equivalent to Amazon in the burgeoning consumer market. 

On a long-term view, its financials have plenty more scope to develop, also more widely in Asia-Pacific, so it is worth being aware of for buying opportunities amid drops caused by the trade situation and Hong Kong.  Results show it's a top-class marketing act likely to win through economic setbacks. Broadly at around $167: Buy.

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.