I put close to 10% of my life savings into Alibaba stock. It wasn’t an easy move to make. Although, I don’t make moves like this willy-nilly. As you’re about to see, the risk-to-reward looks solid.
With Alibaba’s financial data, I’ve built some useful charts. You’ll see a clear picture of the growth potential. There’s a lot you can learn when you dig through a company’s annual reports. And since Alibaba is outside the U.S., it files a 20-F instead of a 10-K.
In this video, I’ve also included a custom discounted cashflow model with price forecasts. But before we get to that, it’d be a mistake not to cover the risks. Too many investors overlook or underweight the potential risk.
When it comes to considering any investment, I always ask…
Why Should I Not Invest in Alibaba Stock?
Starting out, let’s get the market or systematic risk out of the way. The stock market could crash next week… or the next. And that would take Alibaba stock down with it. Although, this type of risk is unavoidable when it comes to investing. Of course, you can hedge it with puts and other strategies… but that comes at a hefty premium, one I’m not willing to pay.
The world’s best investors can’t time the market, at least consistently. And it’s good to keep in mind that there are one-off successes that the media likes to highlight. But this skews reality and isn’t the average.
To counter systematic downturns, all I have to do is play the long-game. If there’s a crash in the near-term, it won’t feel good seeing red in my portfolio. But those will be paper losses and not realized losses…
With history as a guide, the market rebounds. It’s pushed to new highs after wars, pandemics and other crises. I also have an emergency fund so I won’t be forced to liquidate during a downturn. If anything, that will give me even better buying opportunities. I still have too much cash on the sidelines.
The elephant in the room when it comes to Alibaba is geopolitical risk. It’s a Chinese company. If China and U.S. trade tensions get worse, that could hurt Alibaba’s growth and cashflows. The New York Stock Exchange (NYSE) could also be forced to delist Alibaba stock. We’ve seen this happen recently with other Chinese listings.
Alibaba trades on the Hong Kong exchange but I bought the American depository receipts (ADRs) on the NYSE. The geopolitical risk is definitely one of my largest concerns. And this seems to be a major sticking point for other investors as well. As a result, shares of Alibaba look undervalued compared to U.S. based tech stocks. And this discount will likely persist. But with my recent purchase, I believe the geopolitical risk is already well baked into the price.
The last major risk I want to highlight is antitrust risk. The Communist Party of China (CCP) has started to crack down on China’s tech giants. Similar to what we’re seeing from U.S. regulators here.
Alibaba was recently slapped with close to a $2.8 billion fine. That’s huge and we’ll likely see more litigation costs to the business. This stifles growth… Although, antitrust can be a double-edged sword.
On top of these risks I’ve mentioned, there’s also management risk. We’ve seen some headlines around founder Jack Ma recently. Although, I’m not too concerned on this end. The CCP is also treading carefully and doesn’t want to knock down huge companies that succeed for the country.
Alibaba is also facing higher competition risk from JD.com, Pinduoduo and other players. But this is always an ongoing concern. Nonetheless, Alibaba continues to report impressive growth, as you’re about to see. Let’s take a look at its business and revenue…
Alibaba’s Revenue Growth
The numbers I’m about to share I decided not to convert from Yuan (or renminbi) to USD. The main reason for this is that I’m hopefully holding BABA stock for the long-term. I’m not actively trading it… instead, the exchange rate will matter more down the road when I’m exiting the position. And I’m not in the business of forecasting forex changes. Instead, I focus on a company’s growth and fundamentals.
On top of that, keeping it as the Yuan will reduce the chance of errors and keep things more consistent. The exchange rates are always moving between reporting periods. And for the current exchange rate, it’s roughly 6.5 yuan for every U.S. dollar. It’s changed a bit since I was working in Beijing many years back.
Nonetheless, with using Yuan as the currency you’ll still see a clear picture of the important trends. Also, when I get to the final valuation, I’ll convert it to USD.
Alibaba brought in close to ¥510 billion in fiscal year 2020. That’s up 35% from the previous year of about ¥377 billion. You can see the huge revenue growth in this chart…
Alibaba’s fiscal year ends in March so we should have the 2021 annual numbers soon. Although, I couldn’t wait and wanted to share this research sooner than later.
For the first six months of the current fiscal year – April through September – Alibaba reported revenue of close to ¥309 billion. That was up by 32% year-over-year.
For one of China’s largest companies, this growth is huge. It has slowed down a bit over the past few years but that’s to be expected. And when considering the total addressable market (TAM), Alibaba still has a lot of room to grow.
The company has continued to increase its monthly active users (MAUs)…
Over the past year users have climbed from 721 million to 846 million. That’s up 17% and to put this userbase in perspective… China has a population of roughly 1.4 billion people. That’s over four times the population of the U.S. which comes in around 330 million.
Alibaba is well positioned as the Chinese economy moves forward. China’s GDP continues to grow at a higher rate than the U.S. On top of that, more of its citizens are moving up into the middle class. This should lead to higher sales through Alibaba e-commerce platforms.
Business Segments and Growth
Similar to Amazon, Alibaba is also expanding into other high growth areas. Here’s a breakdown of its Alibaba’s revenue by segment…
Cloud computing comes in second with ¥40 billion in sales for 2020. That’s up an amazing 62% year-over-year. And with the world’s insatiable appetite for data and digital content, this segment should continue to grow at a high rate… even with increasing competition.
Expanding beyond core e-commerce is a smart move, as we’ve seen with Amazon. And these segments still have a long way to go, especially on the profitability side.
But before we get into Alibaba’s income and cashflows, let’s look at the balance sheet…
Alibaba’s Mountain of Cash
At the end of September 2020, Alibaba reported close to ¥523 billion in total current assets. And the biggest piece of that pie is cash and cash equivalents. That came in at about ¥302 billion. That’s a mountain of cash and that’s followed by ¥104 billion in short-term investments. Some smaller line items such as prepayments and receivables make up the rest.
On the debt side, let’s pass by current liabilities and instead focus on total liabilities… all short-term and long-term liabilities. This will give a better picture of Alibaba’s rock-solid balance sheet.
Total liabilities come in at ¥452 billion. So, Alibaba easily has enough in current assets to cover all of its debts…
This is a rare position to be in… very few U.S. companies have this strong of a balance sheet. And to stay competitive or for whatever reason, Alibaba could easily leverage up. Although, even then, Alibaba’s free cash flows are likely more than enough…
Cash From Operations to Free Cash Flow
Let’s start by looking at cash from operations…
Since 2016, cash from operations has climbed from about ¥57 billion to above ¥180 billion in 2020. That’s an annual growth rate of over 30%. Of course, it’s slowed down a bit over the past few years. But it’s still moving at an impressive clip.
With this 2020 number we can now work towards finding the free cash flow. To do this, we’ll first want to subtract capital expenditures (CAPEX), which has also been growing at a similar rate. For 2020, CAPEX came in at about ¥45 billion.
Relative to cash from operations, Alibaba isn’t really having to reinvest much to maintain and build the business. And that’s great for shareholders!
From there, we’ll also remove debt payments which came in around ¥16. And as mentioned before, Alibaba has a strong balance sheet with little debt. In most previous years, net debt issuance would have added to free cash flow. Either way, we’re left with about ¥119 billion in free cash flow to equity.
Alibaba DCF Valuation
For 2021 and based on analyst estimates, FCFE might come in around ¥161. That’s based on a 35% growth rate. There was a recent adjustment for Ant Group but this is just a simplified valuation model. I’m intentionally leaving some things out. Although, I’m keeping it on the conservative side. So, we’ll use ¥161 and project out to 2030 with a decreasing growth rate…
I’ve used 2% for the terminal growth rate and I’d say that’s pretty conservative. I’ve also used 10% as the discount rate, which is conservative as well given the current risk-free rate, equity premiums and other rates.
This gives a total present value of ¥5,337 billion. And to get the price per share, we’ll have to divide this number by total shares outstanding…
Shares Outstanding Hong Kong vs. ADRs
It’s important to note that the ADRs represent eight shares. So, we can simply take the total shares reported in the 20-F and divide by eight, similar to a reverse split. And here’s how shares outstanding have changed over the past five years…
There’s a little dilution each year and this makes sense with equity compensation. Shares outstanding are moving at a reasonable rate and eventually Alibaba might buy back stock with its growing pile of cash.
Either way, we’ll just use that to 2020 number of 2.7 billion. And the total present value of ¥5,337 divided by 2.7 gives us ¥1,977 per share. For the last step, let’s do a quick conversion to USD. Using an exchange rate of one dollar to 6.5 Yuan gives us $304 per share.
I bought Alibaba stock at about $211… So, shares are well undervalued based on these estimates and projections. To go one step further, here are some ranges when adjusting the terminal growth and discount rates…
There are many ways to slice and dice company valuations with many assumptions. I used to create more complex models. Although, I’ve learned that more complexity doesn’t usually lead to better forecasts and outcomes. Instead, it tends to make analysts more confident in their projections, which isn’t good if accuracy doesn’t increase as well.
Still, this process is good to get a general idea of what a company is worth, relative to its current market price. I highly recommend reading through Alibaba’s 20-F to get a better understanding of the business.
Overall, I feel the risk-to-reward is solid with my investment in Alibaba stock. Although, as I emphasized earlier, this is by no means a risk-free position. Things might not work out and please do your own research if you decide to invest.
Also, the 2021 numbers are coming out soon… so, I might update my forecast. Please let me know if you have any comments or questions down below.