Comparing the Risks and Fundamentals of Alibaba (NYSE:BABA) - Why Positive Developments are a Good Possibility

First published on Simply Wall St News

The market reacts to current uncertainty and future outlook. Unfortunately, Alibaba Group Holding Limited (NYSE:BABA) shareholders have been faced with painful waiting for a stabilization or dollar cost averaging to little effect. The company currently faces a lot of uncertainty, but it has also made substantial financial progress since its IPO in 2014. Today, we will attempt to weigh the risks and future of BABA as an ADR in the U.S. market.

Current Uncertainty

Some investors downplay the fact that BABA is available to US investors via its shell in the Cayman Islands, and that they are not actually owning the mainland China company, but a separate entity that has contractual obligations. This mattered little until 2020 when investors saw a heating up between U.S. - China relations, as well as the de-facto reformation of the way China envisions their private sector.

Both the risk of further escalation between US-China relations and the higher involvement of the state into publicly traded companies still persist, and may unravel in unforeseen ways. This is partly why the stock has fallen back to IPO price levels, effectively erasing 50% to 70% gains made between 2018 and 2021.

Delisting Headlines

There are currently some headlines (1, 2, 3, 4, 5 etc) associating the SEC's invitation to comply with information regulation for 5 companies which are not associated with BABA, with risks for future delisting.

The implied interpretation is that what is happening to these companies can happen to BABA, however there is little basis for this.

The SEC is deciding to be more rigorous in what should be acceptable information practices from Chinese ADRs, and while this may well be fueled by the current geopolitical situation, it may be over-reaching to imply that BABA is, or will be affected in the near future.

Of course, the situation can escalate, but it can also stabilize, which is why investors might not want to make fast conclusions.

Check out our latest analysis for Alibaba Group Holding

Summary of Risks

AliBaba, has been significantly impacted by changes in Chinese state policy towards publicly traded companies, the heating up between US and China relations, as well as the recent geopolitical developments in which China is tactizing on both sides of the Russia - Ukraine war.

When thinking about the risks, it is also productive to think of positive possible developments. For example, due to escalating of the credit risks and tensions with the west, China might loosen some of the pressure on publicly traded companies. Additionally, China's GDP change YoY is expected to slow, which might be perceived as the beginning of a decline - and the government might further seek to mitigate this image by subsidizing businesses or allowing more temporary leniency in regulation enforcement.

Now, that we have overviewed the surrounding risks, let's remind ourselves of the fundamentals.

AliBaba's Performance Today

As we will see below, the company has been growing revenues at a 29%+ rate in the last 4 years, however margins are slowly declining - The Net Income margins have been hovering around 25% from 2017 to the end of 2020, but have hit single digits in 2021 and 2022, and is currently at 7.83%.

This is a sign of a slow decline, but may be because the company is investing into growth and will have an opportunity to optimize margins in the future - arguably, the company is stronger than 5 years ago, and margins will catch up with growth after the company shifts focus to profit optimization.

There is one more aspect that is crucial to investors, which is why we partly think that the company's profits are undervalued. This is the difference between free cash flows and statutory profits. While we tend to ask about the profits first, it is actually the cash flows that investors are privy to.

For BABA, the free cash flows are CN¥131.1b vs CN¥65.5b in profits - this effectively lifts the margin to 15.6%.

Now we will see what analysts are predicting for AliBaba's future performance.

Taking into account the latest results, the consensus forecast from Alibaba Group Holding's 50 analysts is for revenues of CN¥989.6b in 2023, which would reflect a meaningful 18% improvement in sales compared to the last 12 months. Statutory earnings per share are predicted to leap 50% to CN¥36.41.

It seems that analysts are sticking to the US$176 price target.

That's not the only conclusion we can draw from this data however, as some investors also like to consider the spread in estimates when evaluating analyst price targets. There are some variant perceptions on Alibaba Group Holding, with the most bullish analyst valuing it at US$305 and the most bearish at US$130 per share. Considering that the company is trading at $86.7, it seems that the stock is expected to have significant upside.

Key Takeaways

Given our risk and fundamental analysis, it seems that not everything points to a bleak future for AliBaba investors.

There are reasons that might motivate the Chinese government to show some leniency and lower the pressure on publicly traded companies, especially if they decide to prioritize stronger GDP growth.

Investors are currently weary of the future of AliBaba as a company, as well as their ability to freely invest in the stock. However, should the expectations of bullish investors materialize, they will see significant upside.

Even so, be aware that Alibaba Group Holding is showing 3 warning signs in our investment analysis , you should know about...

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Simply Wall St analyst Goran Damchevski and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.