Alibaba: Is It Time To Buy In?

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Alibaba: Is It Time To Buy In?

MARKET INSIGHTS
09 Jun 2022

Your capital is at risk if you invest. You could lose all your investment. Please see the full risk warning here.

Somewhere around mid-2021, the practice of «er xuan yi» (二选一; «pick one from two») – wherein a merchant is persuaded into an exclusive distribution channel arrangement by an e-commerce platform – was ended in in the inital firing shots of the «tech crackdown» in China. This was a move that would be transformative for China’s «platform economy»: with the playing field evened for all platforms for attracting merchants, the «platform wars» was bound to get very innovative (and costly) over the next few quarters.

Alibaba was the most affected by this, since it had a «first mover» advantage on all other subsequent rivals. Added to this «downward pressure» was the long-anticipated correction in stock valuations in the world’s most overvalued equity market that is currently manifesting today (along with the highest inflation seen in the U.S. over decades) that also served to dampen overall investor appetite in this company in the months since.

One additional red flag was the vexatious issue of consumer finance company/subsidiary Ant Group and its complex relations with the company as well as its principals, which the government had absolutely forbidden. In 2022, this is shaping up towards becoming materially insignificant to the company and rather manageable by investors in terms of risk. There’s every indication right now that the government and its various state agencies are managing the situation without any substantial adverse actions on the company.

With the aforementioned facets in mind, an examination of the fiscals would now be in order, going back from the Fiscal Year results published on the 26th of May.

Trends seen in key line items of the fiscals show:

The company shows remarkable discipline in revenue segments: Commerce in China consistently accounts for 70%, the rest of the world accounts for 5%, and revenue from other segments also show similar consistency. Costs in key items show a similar trend as well.
What’s important, however, is the massive shift in relevance from «Customer management» (i.e. actual internet commerce) to «Direct Sales», i.e. the network of physical stores the company is rapidly building out.
On the whole, however, earnings per «American Depositary Share» (ADS) has dropped by more than half relative to the prior year.

As per the company, this increase was primarily attributed to:

the higher proportion of the direct sales businesses, such as Sun Art, which resulted in increased cost of inventory as a percentage of revenue.
the growth of «Taocaicai» businesses leading to an increase in logistics costs as a percentage of revenue.

The company’s growth in direct sales and «Taocaicai» segments (which represents the bargain-hunting/»value deals» business) are in response to rivals JD.com and Pinduoduo who are dominant players in these segments respectively.

The «Digital Media and Entertainment» segment has traditionally been a mixed bag of sorts. While the «gaming» sub-segment within was considered to be rather promising, it’s «content» sub-segment was typically a cash-burner with little to show for it. Both of these factors have changed in recent times.

Alibaba Pictures ended 2021 with the second-highest grossing movie in the world – «长津湖» also known as «The Battle at Lake Changjin» – which depicted a Chinese military victory over U.S. forces in the Korean War. The film grossed over $902 million worldwide (with the largest contributor, of course, being China itself). Its sequel in 2022 – «长津湖之水门桥» also known as «Water Gate Bridge» – has grossed over $626 million so far this year. The company heralds this as a turning point for this sub-segment.

On the other hand, the company’s gaming sub-segment had also faced pressure during the tech crackdown for reasons that were claimed to be «cultural» in nature by various State organs and unrelated to reining in «tech giants». This perception witnessed a shift earlier this week with approvals granted to a slew of games, following which the stock rose nearly 15% on the 8th of May.

Given all these facts, would this mean it’s a time to start «buying in»? This question needs a more-nuanced consideration.

Ratio Analysis and Price Trajectories

In a style similar to that in past articles, lets take a look at the price ratios for the company’s ADS from mid-2021 (when the crackdown began) till the beginning of this month.

It should come as no surprise, given investors’ appetite for stocks in China, India and the ASEAN belt, that the ADS had a very high market valuation in the past. Given the intensifying competition between the company and its rivals, it’s a logical conclusion that earnings attributable to shareholders will continue to face downward pressure in the mid- to long-term, despite any suggestions to the contrary as evidenced by the recent uptick in the ADS’ price.

Overall, the effects of the «tech crackdown» dovetailing into the current market downturn due to inflationary/recessionary concerns until mid-May, with even suggestions of a weak upward trend. The «weakness» is on account of how recent this trend is; there are currently no suggestions that this will sustain itself.

In the year till date (YTD), the performance of the company’s ADS has a striking relationship with the benchmark tech-heavy Nasdaq-100 (NDX):

After some contrarian behaviour early in the year, the ADS went on to significantly amplify both gains and losses seen in the benchmark. While the current ramp-up might be considered to be at least partially influenced by a trend in rising market prices, it also highlights a weakness: the market is heavily influenced by the overall macroeconomic outlook.

As JPMorgan Chase CEO Jamie Dimon highlighted at a financial conference earlier this month, there are two factors to consider (in addition to the recessionary/inflationary pressures already present):

Quantitative tightening (QT) by the U.S. Federal Reserve which is scheduled to begin this month that will reverse the Reserve’s emergency bond-buying programs – a key source of U.S. government funding.
Energy prices, particularly crude oil, continue to climb – which will also impact savings.

This implies that the market will continue to be choppy and these trends might very well be – to borrow a now-infamous term at the U.S. Treasury Department – «transitory».

The company’s ADS is a key constituent of many China-centric ETFs and indexes such as the Invesco China Technology ETF (CQQQ) and the S&P China Tech 50 Index (SPCT50UP). From 2019 till the present, it’s evident that the ADS is still a very, very long way away from recovering to past highs.

In Conclusion

Given the heating competition between platforms, it’s fairly unlikely that any one platform will go on to dominate the Chinese market any time soon. With that in mind, the company’s current ratios are quite reasonable. However, given the massive global investor interest poised to pile on, there is a possibility that the ratios will get higher.

However, the overall market condition isn’t due to resolve itself any time soon either. As seen in previous iterations of market micro-cycles over this past year, overvalued stocks tend to have bigger falls. Overvaluation leads to high volatility: if the market dips, there is a fair likelihood that the stock will dip hard.

Investors should be wary of going on and also consider this: given that the «platform wars» is largely unlikely to yield a champion in China any time soon. For disciplined tactical investors, there are a wide variety of instruments to capitalize on the current price discovery patterns prevalent with daily-rebalanced inverse and leverage factors embedded. Tactical and agnostic short-term investments in either the upside or the downside via these instruments might just pay out quite handsomely for the savvy market participant.

Your capital is at risk if you invest. You could lose all your investment. Please see the full risk warning here.

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Elaborado por

Sandeep Rao

junio 9, 2022

Category: MARKET INSIGHTS

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