Alibaba (NYSE:BABA) is trading at close to its lowest PS ratio which shows that Wall Street is overlooking the growth potential in a number of segments. In the year ago quarter, Alibaba reported its first YoY revenue decline of 2.5%. Regulatory and macroeconomic challenges in the pandemic caused this decline. In the upcoming earnings, Alibaba would be facing easier comps which should allow the company to deliver better-than-expected growth and build good momentum in the stock. The recent spinoff announcement is likely to have been made after consulting the regulators. This is a very strong signal that Alibaba could see lower regulatory hurdles in the future. As mentioned in the previous article, Alibaba Cloud is also in a good position to leverage new AI tools.
The macroeconomic environment was also quite challenging during the pandemic. Opening the economy should slowly build better growth conditions for the company. The management has also announced that they will be making a major effort in launching their operations in Europe. Alibaba is already a major player in Turkey and Southeast Asia through its subsidiaries Trendyol and Lazada.
The recent growth numbers from Alibaba have not been good. However, the company is in a good position to deliver strong growth in key business segments like cloud, logistics, international retail, and others in the near term.
Things to watch out
The upcoming earnings call will be very important for Alibaba as it will impact the sentiment toward the stock for the next few months. Alibaba has a good tailwind due to easier comp compared to the year-ago quarter. In the June end quarter of 2022, Alibaba posted its first-ever year-on-year revenue decline. The company was facing several challenges which led to a decline of 2.5% in revenue. The cloud growth also stalled in the year-ago quarter, leading to bearish sentiment toward the stock.
However, the recent opening up of the economy and better regulatory environment should give Alibaba a good boost. Alibaba is also launching new AI tools and is one of the main providers of key AI technologies within China. This helps the company leverage its market leadership position within the cloud segment.
Figure 1: Forward PE ratio and YoY revenue growth of Alibaba in the last three years.
The forward pe ratio of stock is quite low at less than 12. Even a modest high single-digit revenue growth should improve the sentiment and lead to bullish calls toward the stock.
Easing regulatory challenges
The regulatory challenges have been a key reason behind the decline in Alibaba’s stock price over the last two years. The announcement of spinoff would have been done with the prior consulting of regulators. This shows that we might see lower headwinds from the regulatory aspect in the future. Alibaba had become too big to fail within the Chinese ecosystem. By spinning off into smaller business segments, the company is less likely to get into regulatory trouble.
Figure 2: Alibaba’s PS ratio in the last few years.
Alibaba traded at a PS ratio of close to 10 prior to the pandemic. We can clearly see a strong bearish correction from the last quarter of 2020 when the company’s IPO plans of Ant Group were canceled. The current PS ratio of Alibaba stock is one-fifth of what it was in the last quarter of 2020. The next few months will be very important to gauge the regulatory environment in China. If additional signs are seen that the regulators will give Alibaba and other companies more freedom, we might see a major bullish run in the stock.
Better macroeconomic conditions
The GDP growth rate in China after the economic opening has been slower than expected. This might push the government to take stronger actions to boost growth. Having a pro-growth policy in the past has helped the government reduce unemployment and improve wage growth. Due to high debt levels, we might not see another debt-fuelled growth in China. The only other option is to increase investment by private companies and give them greater autonomy.
There has also been a slowdown in the growth rate of Amazon (AMZN) and other retail companies. Amazon’s AWS recently reported YoY growth rate of 16% compared to 33% in the year-ago quarter. This slowdown is due to macroeconomic challenges like high inflation, recession fears, geopolitical tensions, and others. We might be close to the trough in terms of these macro challenges. Better economic conditions over the next few quarters should be a strong tailwind for Alibaba as the company prepares to spinoff its business segments.
Alibaba has already shown success in several international regions. Lazada in Southeast Asia is a leading ecommerce platform while Trendyol is a market leader in Turkey. The next major target for Alibaba is Europe, and the company has announced several initiatives and investments in this region. Most of the e-commerce market share is usually cornered by the top two or three companies. We have seen this trend across all the geographies. Amazon is currently the biggest e-commerce company in main European markets. There are several smaller players who are trying to improve their market share in this region.
Figure 3: International commerce growth in the recent quarter.
Alibaba’s International commerce retail posted the highest YoY growth among all the segments. This increased the quarterly revenue base to over $2 billion and also increased the revenue share of international commerce from 7% to 9%. At the current growth trajectory, International commerce should make up more than 25% of the total revenue base of Alibaba. This should help the company diversify its revenue and it also reduces the slowdown risk in China.
Alibaba has the tools and technology to quickly ramp up its e-commerce platform within Europe. The company is already present in Europe through AliExpress but has a low single-digit market share. This can change as the management puts greater focus on this segment after the spinoff. Most of the major economies of Europe have been open to new players from China as it allows them to have a more diversified provider base and more robust competition. This gives Alibaba a good regulatory environment to build its business.
Future trend for Alibaba stock
Alibaba stock is trading at 2 times its PS ratio and has a forward PE ratio of 10. The main regulatory headwinds for the company are likely behind it. Even a single quarter of good YoY growth can result in a strong bullish run in the stock. It should be noted that the company will also see easier comps as the growth rate during the last year of the pandemic was quite low.
The slowdown in growth in the last year should help the company in the next few quarters in terms of easier comps. The spinoff can unlock significant value while the regulatory environment should become easier in the future. Alibaba’s fundamentals are still quite strong and the company has a good market share in e-commerce, cloud, food delivery, logistics, and others. At the same time, it is quickly ramping up its international operations which should be a hedge against any slowdown within China. At a forward PE ratio of 12, the stock is a good option to consider for long-term returns.
Alibaba is trading at close to the lowest PS ratio since its IPO. The announcement about spinning off is quite positive. This should help the company unlock significant value but it also shows that the regulators are giving the company a lot more freedom.
The upcoming quarter would be important for the company because it has the tailwind of easier comps. A strong revenue growth in this quarter can give a strong bullish momentum to the stock. Long term return potential of Alibaba stock remain robust making it a Strong Buy at the current price.
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.