Alibaba: China Data Gets Scary (NYSE:BABA)

In our previous coverage of Alibaba (NYSE: BABA), we saw enough data on the positive side of the ledger that we were able to give it a buy rating.

It would be extremely unlikely for BABA, with the edges they have, but a recession makes it possible. But assuming they can hit their estimates below, we see material upside for the stock. We believe this to a Buy, with a Price target of $90 in one year.

Source: They don’t ring a bell on the bottom

We hit that $90 point pretty quickly, and those who took the trade at the February 8, 2024 low prices made quick money.

We look at recent results and data deluge from China. While the stock is a good distance away from the $90s, we can see why now we return to neutral.

Q1-2025

BABA has a fiscal year that ends in March, so the most recently reported quarter was Q1. While earnings on the Non-GAAP front beat estimates, it was a pretty weak showing for any realistic observer. Revenue was up 4% year-over-year, but everything was down after that. Income from operations, adjusted EBITDA and adjusted EBITDA margins all trended lower.

Net income fell 27%, while the heavily adjusted number also fell 9%. We’ll note here that earnings also missed warm estimates. We did so poorly on all of these metrics despite having a smaller number of quotas.

The commentary was bullish as BABA expects its unprofitable lines to reach a minimum of positive returns in 1-2 years. So far, e-commerce and the cloud have driven the bottom line. A key downside, in addition to the tepid overall results, was the extremely high rate of reinvestment required in the business. Free cash flow is down over 50% year over year.

Analyst expectations

There is quite a gap in the analyst community and you can see that in the gap between the lower end of estimates and the average estimate.

Funnily enough, the only analyst with estimates beyond fiscal 2027 is lower than the 2025 number for both 2028 and 2029. Of course, the key argument is that BABA is cheap no matter how you slice it. Look at those low P/E ratios. But those P/E ratios only tell half the story. BABA has fallen to these levels as it has started producing some of the lowest asset returns you can find.

But can this be reversed? We don’t think that will happen anytime soon.

Data about China

The biggest kahuna for China is the real estate market. We defined it as the biggest bubble on the planet and that’s after we were aware of why more AI stocks are trading these days. Problems are not in sight.

Despite efforts by Chinese regulators to jump-start the housing sector, the housing slump continues to deepen. In August, the value of new home sales from the top 100 real estate companies fell about 26.8 percent from a year earlier to 251 billion yuan ($35.4 billion), according to preliminary data from China Real Estate Information Corp. This compares with 19.7%. % decrease in July.

“The market has been looking for more decisive policy support from the property sector, unfortunately that has not come,” said Clement Chong, head of fixed income research at Eastspring Investments. “Investor confidence in a sustained recovery in the real estate sector is not very high at the moment,” he added.

Source: Bloomberg

Real estate developers’ stocks are getting deeper and deeper into trouble.

China’s attempts to stabilize itself continue to fail on several fronts.

In May, China’s central government urged more than 200 cities to buy unsold homes to reduce oversupply. More than three months later, only 29 have heeded the call.

The glacial pace of implementation — driven in large part by the plan’s unattractive economics for local governments — underscores the challenge facing President Xi Jinping as he tries to stem a record decline in property that threatens to undermine the country’s growth goals.

Source: BNN Bloomberg

The problem is that the prices are still ridiculously high. Just look at the rental yields that are lower than the ultra-low interest rates.

Local bureaucrats are reconciling demands from Beijing while trying to be prudent about costs. Buying apartments right now doesn’t make financial sense for these officials because apartment prices are expected to drop at least another 30 percent in major cities before leveling off, according to Jefferies Financial Group Inc.

Estimated returns from converting inventory into affordable housing are also below the cost of financing. Rental yields in China’s Tier 1 cities averaged just 1.4 percent in 2023, compared with the central bank’s funding rate of 1.75 percent, according to Macquarie Group Ltd.

Source: BNN Bloomberg

We could get another deflationary shock in the coming months, especially if the rest of the world joins the recession.

Under these circumstances, it would be unwise to ignore macro and run after BABA because it’s cheap.

Verdict

The biggest positive development for BABA was that Beijing realized that the country’s deflationary tide would worsen if it destroyed its own stock market. Recent news from the antitrust watchdog essentially validates that this is their view.

China’s antitrust watchdog has ended a three-year regulatory “rectification” process for Alibaba and praised the internet giant for its compliance after fining the company $2.8 billion in 2021 for monopolistic practices.

The State Administration for Market Regulation (SAMR) said it had inspected Alibaba’s process to comply with antitrust regulations in recent years, and the rectification work had achieved “good results”.

Source: Seeking Alpha

Also, you are unlikely to lose much money if you hold BABA here for the long term. There is a lot of underlying value, with almost half of the market capitalization backed by tangible assets.

But retailers can trade cheaply when their margins show a downward trend.

We also believe that these margin levels have come as a result of very high levels of reinvestment in the business. So the owner’s real return, (possibly measured by free cash flow) is much lower. Stocks can dive again if we get into a global recession and those gains can evaporate by at least 50%. We are also likely to see an increasing level of investment in Taobao Group and Tmall, which will put pressure on free cash flow. The same could be said for Alibaba International Digital Commerce Group. BABA looks fundamentally cheap, and while it’s up 25% from our February article, the valuation hasn’t really exploded. But the macro environment looks extremely bad and we think this can remain a value trap for a long time. We are reducing this to a hold and will monitor the story as it develops.

Please note that this is not financial advice. It may seem, it sounds, but surprisingly, it is not. Investors are expected to do their own due diligence and consult a professional who knows their goals and constraints.

Editor’s Note: This article discusses one or more securities that are not traded on a major US exchange. Please be aware of the risks associated with these stocks.