Although the trade war between the U.S. and China has dragged on, shares of Chinese e-commerce juggernaut Alibaba (NYSE:BABA) have largely shrugged off those trade tensions in 2019. So far this year, Alibaba stock is up nearly 30%, versus a roughly 20% gain for the S&P 500 and an approximately 14% gain for the Invesco China Technology ETF (NYSEARCA:CQQQ).
There are three main reasons for the outperformance of Alibaba stock in 2019. First, the consumer side of China’s economy has shown signs of stabilizing and improving in 2019. Second, Alibaba’s revenue growth trends have remained resilient (BABA generated 50%-plus revenue growth again last quarter). Third, its margin trends have improved sequentially for the past three quarters.
Those three factors have driven the huge outperformance of BABA stock through the first seven months of 2019.
For five major reasons, this outperformance will persist for the last five months of 2019, too. Those five big reasons are as follows:
China’s Consumer Economy Is in Rebound Mode
As goes China’s consumer economy, so goes Alibaba, since Alibaba’s main businesses focus on selling goods to hundreds of millions of Chinese shoppers. Fortunately for the owners of Alibaba stock, China’s consumer economy has been on a steady upward trend in 2019.
In the first quarter of 2019, overall retail sales in China rose 8.3%. In the second quarter, they climbed more than 8.5%, including a 9.8% gain in June, the highest retail sales growth rate China has recorded since January 2018. Further, and more importantly for BABA stock, China’s online retail sales growth accelerated from 15.3% in the first quarter to 17.8% in the first half of 2019.
The economic data indicates that China’s consumer economy materially improved over the past three months , especially on the digital front. As a result, Alibaba is well-positioned to report healthy quarterly numbers at the end of August. Those good numbers should provide support for continued gains by BABA stock.
Alibaba Is Adding New Revenue Streams
It’s no secret that Alibaba’s core commerce business is slowing, mostly because the growth of China’s online retail market is slowing as the market gets bigger and more mature.
But Alibaba is now doing something to offset that trend. Specifically, much like Amazon (NASDAQ:AMZN) is doing in the United States, Alibaba is creating tangential businesses that will produce new revenue streams.
At the moment,Alibaba is focusing on selling consumer data to merchants. That business has healthy, long-term potential. We are entering the era of data-driven decision making. Alibaba has an unparalleled amount of data on China’s consumers. That data will only become more and more valuable as data-driven decision-making becomes more prevalent. As a result, Alibaba’s data selling business is likely to grow rapidly for the next several years.
But that is just the tip of the iceberg. There are so many things which Alibaba can and will do to generate new revenue streams. Specifically, BABA can emulate the new things that Amazon is doing in America, like digital advertising, cloud, pharmacy, and logistics. As all these new revenue streams come online over the next few quarters for BABA, Alibaba’s overall revenue growth trajectory will stabilize, and BABA stock will trend higher.
Alibaba Is Going Global
To help it further combat slowing core e-commerce growth in mainland China, Alibaba is finally going global.
Up until now, Alibaba’s marketplace has been open to U.S. buyers but closed to U.S. sellers. Thus, while U.S. consumers could buy stuff from Chinese merchants on Alibaba, U.S. merchants couldn’t sell products to Chinese consumers on Alibaba.
That’s all changing now. Alibaba recently began letting Americans sell products on the platform. BABA is charging Americans $2,000 to sell products on BABA’s website, but that fee won’t meaningfully lower demand because this is a unique opportunity for small and medium American merchants to increase their global addressable market by several fold.
Consequently, over the next several quarters, a flurry of U.S. merchants will flock to Alibaba, and this rush of new sellers will provide a sizable tailwind to its revenues in the second half of calendar 2019.
Margins Will Continue to Improve
Declining profit margins have been a big problem for Alibaba for the past several years. The company has been investing a tremendous amount in new growth initiatives. Those investments come with hefty costs, and those hefty costs have eroded BABA’s margins.
A few years ago, BABA had 40%-plus net profit margins. Today, its net profit margins on a trailing-12-month basis are below 25%.
But this margin compression trend appears to be in the process of reversing course. In fiscal 2018. BABA’s net profit margin was 29.6%, down more than 3.6 percentage points from fiscal 2017. In the second quarter of fiscal 2019, BABA’s profit margin for the trailing 12 months declined just 2.4 percentage points versus the previous year. In Q3 and Q4, the positive trend continued.
Thus, the company’s margin compression trend has significantly and consistently moderated over the past several quarters. This trend should persist for the foreseeable future.
Alibaba’s investments are finally starting to wind down, and the company’s nascent hyper-growth businesses (like the cloud) are starting to grow meaningfully. They will continue to scale over the net few quarters, and that growth has the potential to raise the company’s margins further, boosting Alibaba stock.
Alibaba Stock Remains Attractively Valued
Last, but not least, Alibaba stock remains attractively valued.
Relative to its history, Alibaba stock is pretty cheap at this point. Over the past five years, BABA stock’s average forward earnings multiple has hovered around 29. Today, the forward earnings multiple sits around 26. Its sales, cash flow, and EBITDA multiples are also below their historical averages.
Relative to its growth potential, Alibaba stock is also pretty cheap. According to YCharts, analysts, on average, expect Alibaba’s long-term earnings growth to be roughly 22%. That seems conservative. My calculations indicate that the company’s earnings growth rate will be closer to 25% over the long-term.
Nonetheless, trading at 26 times its forward earnings, BABA stock has a price-earnings/growth (PEG) ratio of narrowly above one, which is really good in this market (the S&P 500 trades at a PEG ratio north of 1.2).
Indeed, my calculations indicate that Alibaba stock’s fundamentals will enable it to climb to $200 over the next few quarters.
The Bottom Line on BABA Stock
Although the U.S.-China trade war has dragged on in 2019, BABA stock has shrugged off that noise, climbing 30% this year, thanks to increasingly favorable and improving core fundamentals. Those core fundamentals will continue to improve in the back half of 2019. As they do, BABA stock will continue to trend towards $200.
As of this writing, Luke Lango was long BABA and AMZN.
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