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Value investors who bought Alibaba Group (NYSE:BABA) on relatively favorable valuations and news of Charlie Munger doubling down lost plenty of money.
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BABA stock broke down below the $160 20-day and 50-day moving averages last week after posting quarterly results. The company forecast revenue will grow at rates not seen since it debuted in public markets in 2014. The Chinese Communist Party (CCP) engineered a slowdown through an onslaught of regulatory reforms, including its “Common Prosperity” program.
Why should recent buyers expect the dip to end? More importantly, when will the stock stop falling?
Q2 Earnings Erosion Hurt BABA Stock
In the second quarter, Alibaba posted revenue growing by 29% to RMB 200.69 billion ($31.15 billion). Non-GAAP earnings per share of RMB 11.20 ($1.75) was on $2.329 billion in income from operations. This values BABA shares at a price-to-earnings ratio in the teens.
Before the regulatory crackdown and endless penalties, investors could call Alibaba a cheap alternative to Amazon (NASDAQ:AMZN). That comparison is no longer valid. Amazon is free to invest its enormous cash flow back into the business. AMZN shareholders do not have any penalties to consider.
On the conference call, CEO Daniel Zhang did not mention Common Prosperity costs in the years ahead. Instead, he said that Alibaba will prioritize offering Taobao Deals to customers. The company first announced this bargain marketplace in March 2021, running as a mini-program on Tencent’s (OTCMKTS:TCEHY) WeChat. Looking ahead, it will invest in the infrastructure. It will build the manufacturing to support the consumer model, which will lead to sales growth from Taobao Deal.
The non-GAAP reconciliation reveals that Alibaba excluded material costs. For example, it incurred RMB 11.88 billion ($1.7 billion) for the purchase of property and equipment. The report excludes its pledge for $15.5 billion for China President Xi Jinping’s Common Prosperity drive.
Opportunity in High National GMV
Alibaba must avoid further restrictions from the CCP. It is embracing connectivity and openness for its consumer sides, including Taobao. Customers benefit from a positive experience that also gives competitors a fair chance. This non-monopolistic behavior might satisfy the Chinese government.
Alibaba’s revenue growth forecast of between 11% to the mid-teens in the second half of 2022 is a sharp decline from growth in the first half. CFO Maggie Wu said it expects a significant drop in China’s GDP and consumption. Alibaba has a high gross merchandise volume of 44% of national totals. After the contraction ends, Alibaba’s high national gross merchandise value (GMV) will lift revenue growth rates.
Alibaba booked infrastructure costs in the quarter to prepare for the rebound in growth. It is building infrastructure capacity to enable merchants to join its platform. CFO Wu offers details next month on this initiative.
The company has a market app strategy to strengthen user engagement. First, it needs to build the user base. In the coming years, the higher traffic to the app will eventually offer monetization opportunities. Then it may expect GMV growth. On the merchant side, Alibaba has many planned service provisions. This includes more services for the local segment, one-stop full service for manufacturers, and everyday services for local communities.
It will also create value for merchants and strengthen its offerings for customers.
Beijing Bureaucrats Pose Risks
CCP bureaucrats pose an ongoing, major risk that Alibaba shareholders cannot anticipate. Markets may react negatively to new regulations that protect Chinese citizens but hurt Alibaba’s competitive position in the e-commerce market. The stock may stop dipping to new 52-week lows in the absence of such news.
Shareholders get a bigger margin of safety the more the stock falls. Should the valuations in American firms like Amazon start slipping, bargain hunters may start a position in Alibaba shares.
At the macroeconomic level, the CCP is de-leveraging its real estate market. It introduced new rules that limit the debt levels of real estate property firms. The Chinese government said that real estate is for living, not for profits or speculation. The slowing real estate market will harm the country’s GDP.
Consumers may limit spending in the coming months. Other than decent sales levels from Single’s Day that drew US $84.54 billion in GMV, Alibaba’s revenues will likely stall in 2022.
BABA Stock Has Bullish Analysts
Wall Street analysts have a bullish average price target of $262.25 on BABA stock, in a range of $192-$407 a share, according to Stock Rover. The stock also has strong quant scores on all three key metrics of value (81), growth (91) and quality (95).
Expect the value score to increase if the share price falls. Alibaba shares have risks of the growth score falling as the quant system re-forecasts its future sales. The quality score could fall if Alibaba’s operating expenses increase.
Investors buying Alibaba are justifiably attracted to the company’s health. Conversely, Beijing’s ever-changing market rules add to the confusion in forecasting Alibaba’s near-term prospects.
Alibaba shares will stop falling when the CCP hints that it will introduce no new reforms to the e-commerce market. This could take a while. The party markets its Common Prosperity initiative as protecting its people. It will destabilize the power companies have on the market. This will hurt Alibaba’s profit margins.
Alibaba’s only options are to invest in the business to increase customer satisfaction. Its infrastructure investments will pay off when demand inevitably recovers.
On the date of publication, Chris Lau did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Chris Lau is a contributing author for InvestorPlace.com and numerous other financial sites. Chris has over 20 years of investing experience in the stock market and runs the Do-It-Yourself Value Investing Marketplace on Seeking Alpha. He shares his stock picks so readers get original insight that helps improve investment returns.
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