Andrew Burton
Downgrade to hold
Readers following our articles know that we have been bullish on Alibaba (NYSE:BABA) in the past 1~2 years. Well, this update is our throw-in-the-towel article. In the remainder of this article, we will detail why we’ve changed our mind and downgraded the stock to a HOLD after weighing several factors, including its attractive valuation, China’s macroscopic risks, and downward technical trading pattern.
There’s no doubt that Alibaba is currently very attractive priced. As seen in the next chart below, BABA’s FY1 P/E ratio currently sits in the single digits, in a range between 7.57x to 8.72x based on its 2024 consensus estimated EPS. This is a huge discount compared to either its Chinese or U.S. peers. While such low P/E ratios suggest a potentially deep discount, there are reasons to hold off on buying just yet. And next, I will elaborate on the top two looming shadows on my mind: the downward trading pattern and the macroeconomic risks in China.
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Technical analyses
BABA technical chart (see the next chart below) reads like a textbook downward consolidation pattern in my eyes, indicating difficulty for the stock to break out in the near term.
To wit, the ADSs nosedived from a high of nearly $100 in about six months to the current level of $77. The overall trend for BABA stock appears to be downward over the past few months. The price has been making lower highs and lower lows. During the latter half of this period, the ADS have been largely whipsawing between a price range of $70 and $80. The most trading volume occurred in a price range of $70 to $76 as seen. To me, this suggests that a larger number of buyers and sellers are evenly matched in this price. The stock will be struggling to break out of this range till these buyers and sellers are replaced.
StockCharts
China’s macroscopic risks
In addition to the technical analyses above, the looming shadow of macroeconomic risks in China forms the fundamental reason for my change of rating. On this front, I think the recent warnings issued by Goldman Sachs Wealth Management CIO, Mossavar-Rahmani, sum up these risks very nicely (and readers interested in a full account of her warnings can read the link in its entirety). Here, I will quickly summarize the gist. In summary, the CIO warned investors about investing in China despite the current attractive valuation for the following four reasons. And in my view, each and every one of them can be applied to BABA. Reason 1 involves the expected slowdown of China’s economy in the next 10 years. Mossavar-Rahmani believes that the three pillars of China’s economic growth: The real estate market, infrastructure, and exports, will all face a weak situation. Reason 2 involves the lack of clarity in China’s policymaking. Coupled with uneven economic data, this has added to her concerns about investing in China. The third reason involves China’s real estate industry, which has not yet bottomed out, even though China may introduce some short-term stimulus measures. Finally, Reason 4 involves the authenticity of the economic data released.
Other risks
Besides the above macroscopic risks, which face all China stocks (or even some foreign stocks) commonly, BABA also faces some key risks unique to itself. On the top of my list is the VIE structure. Alibaba uses a Variable Interest Entity (“VIE”) structure to list its shares on foreign exchanges. This structure can be complex and opaque, and there’s a risk that regulators could challenge it in the future. This could lead to uncertainty and a decline in BABA’s stock price. The second top risk on my list is BABA’s reliance on Alibaba Cloud. With BABA’s heavy reliance on its Alibaba Cloud, I’m concerned about its revenue diversification and also the potential sudden shift of policy that can impact its top clients. Finally, I’m also concerned about the potential scrutiny of its e-commerce practices. Alibaba has recently faced scrutiny for anti-competitive practices within its e-commerce marketplaces. If found guilty, this could lead to fines, restrictions on its business practices, and damage to its reputation.
Upside risks and final thoughts
Although there are some upside risks at the same time. The company is looking to ride the artificial intelligence wave and is making a big push into artificial intelligence. They plan to invest heavily in AI across businesses, including developing generative AI capabilities in their cloud unit. Given the earlier stage of the AI space, BABA’s initiatives (such as Zhipu) hold ample upside over the long haul. In the meantime, the company is engaging in a quite dramatic restructuring, which could potentially increase efficiency, promote innovation, and unlock shareholder value. Leadership is working on a plan to spin off certain assets. However, these developments are occurring, and the eventual outcomes are quite uncertain in my view at this point. For example, leadership has recently halted the spinoff of the Cloud Intelligence Group. Regulatory hurdles are cited as the cause to make initial spinoff plans unachievable. Although other segment spinoffs, including Cainiao Smart Logistics Network Limited and Alibaba International Digital Commerce Group, are still on track to go the public market route.
All told, my overall conclusion is that the risks currently outweigh the rewards, leading to our downgrade of the ADS from Buy to Hold. To reiterate, the key factors that went into our considerations are the attractive P/E ratio, the downward technical trading pattern, and both the macroscopic risks and risks unique to BABA. Alibaba’s current valuation is truly alluring. However, given the fundamental risks and the downward consolidation pressure, our view is that it’s unlikely for the stock to break out of the $70~$80 range in the near term.
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.
