Alibaba stock has priced in very high growth expectations.
Notwithstanding the increasing rhetoric and threat of a full-blown trade war between the United States and China, shares of Chinese eCommerce giant Alibaba (NYSE:BABA) have continued to outperform the broader market. Alibaba stock is up solid 35% in the last one year and over 11% in the year-to-day period, outperforming the Nasdaq Composite (INDEX:COMPX). It is true that Alibaba stock has suffered whenever the rhetoric and threat of a trade war intensified, but it has always managed to bounce back on the strength of its fundamentals.
Alibaba stock price supported by huge growth expectations.
However, with the company trading near its all-time highs, investors are worried about the future potential of the stock. Alibaba stock has priced in a lot of growth. Value of a share consists of two parts: a) value of assets in place and b) the present value of growth opportunities. In Alibaba's case, the value of the assets in place can be derived using the company's recent earnings and its cost of equity. In FY 2018, Alibaba reported diluted EPS of $4. Since we are valuing Alibaba in USD we will calculate company's cost of equity also in USD.
For calculating the cost of equity we need three variables, a) risk-free rate, b) market risk premium and the beta of the stock. We will use U.S 10 Year bond yield of 2.89% as risk-free rate, US market risk premium is currently of 5.5% and Alibaba's beta of 2.54. Using the above-mentioned values, we arrive at a cost of equity of 16.86% (2.89%+(2.54*5.5%)) for Alibaba. So the value of assets in place is $23.72 (4/.1686) per share, which is around 12.5% of its current stock price.
This means that the remaining 87.5% of the stock value is attributed to the company's growth opportunities. This is high even when compared to other tech companies. The question now is whether the company can meet its growth expectations? Right now the company seems to be on the right track. The company is doing well (to put it modestly) in most of it its operating segments. In the previous quarter, Alibaba delivered beat on both earnings and revenue consensus.
eCommerce segment growth continues.
Despite its size, Alibaba's eCommerce segment continues to deliver very strong revenue growth. Revenue from core commerce increased 60% year-over-year to RMB 214,020 million (US$34,120 million) in FY 2018. Taobao and Tmall GMV accelerated its growth from the 22% growth FY17 to 28% growth in FY18. This growth is likely to continue in the coming years, backed by rising income levels and customer additions due to the shift towards online shopping.
Also, Alibaba is still gaining market share in the China e-commerce market. With the help of technology and consumer insights, the company is able to put the right products in front of the right customers at the right time. According to analyst Brian Nowak from Morgan Stanley, Alibaba's total addressable market (TAM) in China is in the range of $6.3 trillion to $7.2 trillion. Alibaba has still huge room to grow. Alibaba is also investing in South East Asia and India, two of the fastest growing eCommerce markets.
Alicloud to expand in multiple geographies.
Aliyun, Alibaba's cloud computing division is becoming a major growth driver for the company. A couple of years back, Alibaba Cloud’s President Simon Hu declared, "Our goal is to overtake Amazon in four years, whether that’s in customers, technology, or worldwide scale." The company is on track to meet its target. Despite its increasing size, Aliyun has managed to sustain its scorching growth pace. In FY18, Aliyun contributed US$2,135 million in revenues, up by a massive 101% YoY.
The company has been consistently posting high growth rates over the past several quarters. Given the low penetration and increasing shift towards cloud, Alibaba has huge growth opportunities in Chinese market alone. The company is also focusing on high-value services which will benefit its bottom line. But the company is not restricting itself just to China. It has global ambitions. The company last year announced its intention to launch data centers in Mumbai and Jakarta and Malaysia. Including the three new facilities, the total number of locations will be 17, covering mainland China, Australia, Germany, Japan, Hong Kong, Singapore, the United Arab Emirates, and the US.
Ant Financials is on the way to biggest IPO listing since Alibaba.
In 2010, Jack Ma pulled out a multi-billion coup by carving out payment business from eCommerce giant on the pretext of regulatory compulsion, leading to a huge loss for existing shareholders like Yahoo and Softbank. After vociferous protest from shareholders, an agreement was eventually reached where Alibaba was guaranteed 37.5% of the future profits of Alipay or a payment of $2bn-$6bn in the event of an IPO. The payment business has grown leaps and bound since then, riding on the cashless payment boom in China. The company benefits by being part of the broader Alibaba empire, which is blazing its own trail in eCommerce. The payments for most of the purchases done on Alibaba's eCommerce portal are made through Ant Financial.
Alipay has also gained broader acceptance from brick and mortar stores. More than 8 million brick-and-mortar stores in China and 120,000 retail outlets across the world already accept Alipay. Consumers used Alipay last year to make $8.7tn in payments, according to Barclays.
Increasingly, Ant’s income will be generated not by Alipay but by the other units in its portfolio, such as its money market fund and its lending operation. With $230bn under management, the company has the world’s largest money market fund. It controls one of the largest credit scoring systems in the world, collecting data on its hundreds of millions of users in China. The companies operations also include a bank, an insurer and a lending platform for small businesses. The company has also struck deals with mobile payment platforms like Kakao Pay in South Korea, Paytm in India, GCash in the Philippines and Dana in Indonesia.
It is no wonder then that Alipay is generating huge investor interest. Alipay recently closed its latest funding round having raised $10 billion from a clutch of global and local investors at a valuation of $150 billion. The company was valued at $60 billion in its previous funding round in 2016. This is good news for Alibaba's shareholders as the company has planned to swap its 37.5% of Ant’s pre-tax profit (which was worth over $300 million last year) for 33% stake in the company. Under its new valuation, a 33% stake in Ant Financial would now be worth $50bn.
Can Alibaba deliver on its growth expectations?
Alibaba's revenue has been growing at a rapid pace, especially for a company of its size, without compromising on its bottom line. In FY18, the company registered a revenue growth of 58%. The company is firing on all cylinders and increasingly focusing on global expansion to drive its revenue growth. Alibaba stock has recently taken a hit as the probability of a full-blown trade war is rising. BABA stock is down almost 10% in the last couple of weeks. The stock is likely to remain under pressure as tension between U.S and China rises. However, in the long term, Alibaba stock looks a good bet. Investors could use the recent correction to establish new positions in the stock.