Interactive Investor

Stockwatch: top US investors think this share is a bargain 

8th June 2021 10:43

Edmond Jackson from interactive investor

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Our stock picker made a great call backing China’s e-commerce giant. Here's what he thinks now.

It looks timely to update on Asia Pacific’s answer to Amazon (NASDAQ:AMZN) – e-commerce retailer and cloud computing services group Alibaba (NYSE:BABA), which nowadays has a New York listing. 

Quarterly results filings are a tad late to interpret, but growth stock guru Cathie Wood, founder, CEO, and chief investment officer of Ark Invest, accumulated her funds with Alibaba during 2020, and a couple of Warren Buffett acolytes bought in keenly during the first quarter.

Charlie Munger, Buffett’s right-hand man, now has around 20% of his portfolio in Alibaba and Mohnish Pabrai (an Indian/American businessman with hedge funds inspired by the mid-20th century Buffett partnerships) is 14% exposed – both heavy weightings.  

Also, an investment fund co-founded by former US vice president Al Gore allocated 1.6% of its assets to Alibaba during the first quarter, helping make it the fourth most actively bought stock on the New York Stock Exchange (NYSE). Altogether, eight leading investors raised their positions. 

Massive Chinese rewards weigh against political risks 

These buyers did not appear rattled by 12 April news of a US$2.8 billion equivalent, anti-trust fine from the Chinese authorities. Initially, this appeared to clear the air of such fear, given the stock jumped from $223 to $242, but it then fell back to $207 on 13 May. Currently it has recovered to $217 which capitalises Alibaba at $582 billion. 

Although the stock is down nearly a third from $310 last October, its chart has quite a whipsaw profile – as could be rationalised from a higher risk/reward profile. It balances between greed - how this is “the next Amazon” and in the world’s most promising consumer market where Amazon failed - and fear at the Chinese authorities’ influence.

This was particularly clear last October when Alibaba founder Jack Ma went missing for three months after making a controversial speech criticising Chinese regulation of digital finance. His remarks angered the establishment which halted the flotation of Ant Group, a mobile finance app he set up. He was not seen publicly until January, amid rumours he was under house arrest or might not even be alive. 

I initially drew attention to Alibaba by way of its September 2014 flotation on the NYSE, which looked to offer a lucrative situation for years if not decades ahead. The market appeared to acknowledge this, trading at $93 after listing at $68. Back then, Alibaba had only a tenth of Amazon’s revenues, albeit a 57% operating margin – massively ahead of eBay’s 28% and Amazon’s 1%. It already boasted an 80% share of China’s online sales, the world’s largest internet market that is twice the size of the US. Its forward price/earnings (PE) ratio around 40x compared with Amazon on 170x. 

The price rose mainly from 2017, and I drew attention again as a ‘buy’ at $167 in August 2019 after second-quarter results showed a 42% hike in revenue. Net income had soared 150% and earnings per share (EPS) by 146%, beating expectations by 22%. Where do you find businesses with vigour on such scale in the West?  

It was a similar tale back then of political risk. Alibaba and other China-related stocks had fallen 10% since that May after US/China trade tensions flared, as did pro-democracy violence in Hong Kong. I thought that, overall, Alibaba looked a slick equivalent to Amazon in the world’s fastest-growing consumer market and its top-class marketing act would win through overall. 

That view would appear to be shared by leading US investors lately, using periods of political fear to accumulate stock. The Chinese government is understood to be investigating Alibaba on anti-monopoly grounds, but this is not exclusive: 12 companies have recently been fined for such violations.  

Annual results to 31 March reflected ongoing dynamism 

Alibaba has passed a milestone of one billion active consumers globally, within which 891 million are in China. These fuelled 32% organic annual revenue growth from core commerce activities but, as with Amazon’s ‘Azure’ side, there was 50% growth in cloud computing services. Alibaba is also now the world’s fifth-largest artificial intelligence (AI) company. The acquisition of Sun Art, a Chinese hypermarket and e-commerce group, took total revenue up 41%. 

The summary table (below) shows impressive top line growth in recent years, and the set-up has enabled free cash flow to soar from around 2 billion Chinese Renminbi to 135 billion lately – an equivalent over $21 billion. Like with Amazon, there is no dividend, but that stock has anyway delivered annualised returns of about 33% anyway during the last decade.  

Among other key statistics, Alibaba’s 10-year median return on invested capital is over 30% and its return on equity over 22%. 

Alibaba Group - summary income statements
Year to 31 March

Renminbi/Yuan billions 2018 2019 2020 2021
Total revenue 250 377 510 717
Cost of revenue 107 207 282 421
Gross profit 143 170 227 296
Operating expenses 72.9 112 134 206
Operating profit 70.4 57.8 93.0 89.7
Interest expense 3.6 5.2 5.2 4.5
Other income/expenses 3.1 -0.4 5.9 7.6
Pre-tax profit 100 96.2 167 166
Taxation 18.2 16.6 20.6 29.3
Continuing operations' profit 61.4 80.2 140 143
Diluted earnings/share (Yuan) 24.5 33.4 55.9 54.7

 

The anti-trust fine was accounted for in Alibaba’s fourth fiscal quarter and meant a 73% jump in annual selling/general/admin costs – slashing net profit growth to 2% growth and with EPS easing 2% after a November 2019 stock offering. Without the fine, operating income would have risen 48%. 

Guidance for the March 2022 year is for circa 30% revenue growth which is very hard to find elsewhere in global stocks. By way of comparison, you would have to assume a behemoth such as Microsoft (NASDAQ:MSFT) can sustain exceptional revenue growth after Covid-19 boosted demand for software/hardware (for remote working). But its chart looks worryingly parabolic, especially now governments are closing offshore arrangements where big US tech firms avoid tax. 

Trailing PE around 25x versus over 60x for Amazon 

The basic valuation disparity continues and, while the likes of Bill Ackman favours retailer Lowe’s Companies (NYSE:LOW) as his hedge fund’s biggest stake – as a means to combat inflation, via essential service stocks – with a PE of around 20x. Who knows if inflation rises substantially and sticks, but markets currently assume the “all shall be well” 2% inflation narrative coming both from the US Federal Reserve and its ex-chair, Janet Yellen who is now US Secretary of the Treasury.  

If inflation racks up like Ackman predicts is now unavoidable, growth stocks on fancy PEs will take a proper bath.  

If goods inflation tempers before wage inflation can take hold, the likes of Amazon may retain big PEs. But the downside risk to many US growth stocks is potentially great, hence no surprise that top US investors are looking to the Far East – also to mitigate investment risk by way of exposure to faster-growing consumer markets. 

Technically not bottomed out? 

Chartists would probably say there is no confirmation of an uptrend and you might be wiser to wait for confirmation of a bottom. That would accord with the cautious view about how the Chinese government also operates behind the scenes and is anti-Alibaba. 

On a chart view since flotation however, and especially since 2017, the share price is sitting on the long-term trend line. Its recent weakness is nothing special.  

I should like next to examine peer retailer JD.com (NASDAQ:JD), also listed in New York besides Hong Kong with a capitalisation of $116 billion. But Alibaba’s circa 30% slide and intelligent US investor buying leads me to re-iterate: Buy

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

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