Alibaba (NYSE:BABA) announced its third-quarter earnings on Jan. 30. Investors liked what they heard, as they sent BABA stock up almost 7% on the day.
BABA climbed even though Chinese stocks had a horrible day, as 20 of the country’s companies warned that their full-year earnings wouldn’t be nearly as good as they had initially thought.
Before getting into some of the finer points of the report and what investors should do with BABA stock, I think it makes sense to answer a fundamental question: Should investors even be considering Chinese stocks at this point in the game?
China’s Micro and Macro Outlooks Are Both Bad
I’m not an economist, but it’s clear that the Chinese economy is slowing dramatically. Many Chinese companies, including Alibaba, are lowering their guidance for the next few quarters, suggesting that the trend in China is anything but investor-friendly.
In fact, Alibaba’s revenue grew at the slowest rate since 2016. However, CEO Daniel Zhang’s optimistic comments seemed to quell any concerns about BABA slowing down. He said:
“Alibaba had another strong quarter. Our resilient operating and financial performance is a direct reflection of our persistent focus on better serving our growing base of nearly 700 million consumers across retail, digital entertainment and local consumer services. Our growth is also driven by the power of Alibaba’s cloud and data technology that helps expedite the digital transformation of millions of enterprises.”
As for the trade war between the U.S. and China, BABA doesn’t feel it will affect the company, since Alibaba is focusing on its domestic market, rather than external matters. While it’s true that Alibaba could continue focusing exclusively on China for years, its cloud business won’t become an Amazon (NASDAQ:AMZN) killer if it doesn’t move beyond Asia.
The micro and macro concerns facing Chinese companies — and not just Alibaba — make investing in them a risky proposition at this point.
The Elephant in the Room With BABA Stock
InvestorPlace’s Vince Martin recently had this to say about Alibaba’s financials:
“The company’s accounting is notoriously opaque. There’s little oversight of the company’s spending, limited transparency, and essentially zero power for shareholders who, again, aren’t actually shareholders. Rather, they own a VIE (variable interest entity) which is entitled to a share of Alibaba’s profits.”
I get emails from an investment pundit who goes by the name of Deep Throat. He’s been critical of Alibaba’s finances for several years. Deep Throat’s latest critique included an interesting observation about the company’s balance sheet.
“Questionable Assets (Investment Securities, Investment in Investees, Intangibles & Goodwill) increased a whopping US$10 Billion in the quarter (That’s 33 Trump Towers in just One Quarter folks!…..Yowzahh!!),” the author wrote on Jan. 30. “Again, no real, rational explanation. This crap-olla just keeps going up. It’s 58% of the balance sheet now….up from 0.0% in 2015.”
I went back to Alibaba’s 20-F filing to check on Deep Throat’s assertions. Based on Deep Throat’s criteria, I found that “questionable assets” compromised 40% of its balance sheet in 2015, not 0%, as the author reported.
Nonetheless, it’s fair to suggest that Alibaba does have a lot of moving parts, too many in my opinion, given the current headwinds facing it, for a regular investor to endure.
Considering the concerns about BABA stock in particular and China in general, I have to wonder why any regular investor (I’m talking about non-professionals) would bother putting their hard-earned capital at risk by buying BABA stock.
Wouldn’t it make sense to wait for two things: an improvement of the Chinese economy and a trade agreement between the U.S. and China?
The Quarter’s Niceties
One of the things I like to see in a potential investment is free-cash-flow growth.
In Q3, Alibaba’s free-cash flow increased 10.8% to $7.5 billion. In the nine months ended Dec. 31, BABA’s free-cash flow rose 2.9% to $13.6 billion. On an annualized basis, that works out to a little more than $18 billion, or 44% of its revenue.
That’s nothing to sneeze at. By comparison, Amazon’s free-cash flow is 6% of its revenue. Even though its profitability is slowing, Alibaba is a cash-flow machine.
I won’t get into the company’s revenues and profits. You can read about those here.
The other thing that caught my attention about Alibaba’s Q3 report was its cloud business, which grew 84% year-over-year to $962 million. Its cloud business represents less than 6% of Alibaba’s overall sales and is losing money.
However, if the percentage of sales that BABA derives from the cloud ever reaches at least 10% and the business becomes profitable, the cloud could become a huge profit driver for BABA and a major positive catalyst of BABA stock, in much the same fashion that Amazon’s cloud business drove AMZN’s bottom line and stock much higher.
It’s an enticing possibility for the owners of BABA stock.
The Bottom Line on BABA Stock
I’ve generally been a fan of Jack Ma and Alibaba stock
In early November, I included BABA stock in a list of seven Chinese stocks to buy while they’re down. Since then, BABA stock has risen about 15%, which is good news.
However, given all of the question marks facing BABA stock at the moment, I don’t think anyone should consider investing in it with retirement funds . Alibaba stock is too darn risky for that. But I do hope I’m wrong about it.
As of this writing Will Ashworth did not hold a position in any of the aforementioned securities.
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