With the coronavirus pandemic accelerating the adoption of online shopping, Chinese e-commerce stocks have outperformed the broader market. JD.com (JD) has surged by 103% in one year. During the same period, Pinduoduo (PDD) stock has moved 274% higher.
However, there is an exception. Alibaba (BABA) has gained just 11% even as the company’s core e-commerce business continues to deliver strong numbers.
The reason BABA stock has lagged is no secret. With regulatory headwinds resulting in the suspension of the Ant Group IPO, investors have been cautious about Alibaba. However, China’s central bank governor has already suggested that the Ant Group IPO can get back on track once issues are ironed out.
It’s very likely that focus will shift to Alibaba’s valuation, growth and fundamentals. Without a doubt, the stock looks attractive at the current P/E ratio of 24.4, and thus, it would not be surprising if the stock outperforms the index and its peer group in the next 12-18 months.
Value Creation From Alibaba Cloud
When considering Alibaba as an investment idea, a significant focus is placed on the company’s e-commerce business.
However, in the next five years, Alibaba Cloud is likely to be another cash flow machine for the company. Going back to 2018, Alibaba’s CEO had opined that the company aims to make computing its main business. Additionally, last year, management indicated that it will invest $28.26 billion in the cloud business over the next three years.
The cloud business has already delivered a strong performance. For FY2020, the company reported 50% year-over-year growth in the segment, with the business also seeing positive adjusted EBITDA for the first time.
As operating profits accelerate, the cloud business will most likely help BABA stock re-rate. It should be noted that Alibaba Cloud is already the largest Infrastructure as a Service (IaaS) provider in Asia Pacific.
Core E-Commerce Growth
The company’s core e-commerce business has also remained a key point of strength. For FY2020, the company’s e-commerce growth was 38% on a year-over-year basis.
Estimates suggest that China’s e-commerce sales will increase from $2.2 trillion in FY2020 to $3.6 trillion in FY2024. Landing among the largest players in the space, Alibaba is well positioned to benefit from industry tailwinds.
Another important point to note is that Alibaba’s e-commerce growth is not limited to China. The company owns a majority stake in Lazada, which is one of the top players in the Southeast Asia e-commerce market. Lazada has continued to report triple-digit order growth on a year-over-year basis.
Therefore, China and Southeast Asia will ensure that core e-commerce top-line growth remains strong. Furthermore, the segment should continue to generate robust cash flows and support investments in the cloud business.
Alibaba has ample financial headroom to pursue aggressive organic and inorganic growth. To put things into perspective, the company reported non-GAAP free cash flow of $14.7 billion for FY2020.
FCF will likely continue to accelerate in the coming years. In addition, the company reported cash and short-term investments of $70 billion as of December 2020.
What’s more, BABA boasts an innovation initiatives segment, which is focused on supporting new seed businesses. Given the financial flexibility, Alibaba can invest in high-growth businesses that deliver long-term value.
Wall Street’s Take
BABA’s Strong Buy consensus rating breaks down into 18 Buys versus a single Hold. With an average analyst price target of $325.38, the upside potential comes in at 44%. (See Alibaba stock analysis on TipRanks)
Amid the recent market downturn, overvalued stocks witnessed sharp corrections. That said, value investing is one way forward and BABA stock is trading at attractive levels. What’s more, downside risk seems limited at current levels and upside potential is significant.
In the next five years, Alibaba is likely to have two segments (core e-commerce and cloud) that deliver strong cash flows. In addition, investments in new business ideas are likely to yield results.
Disclosure: On the date of publication, Faisal Humayun did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Disclaimer: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities.