Shares of Chinese technology giant Alibaba (NYSE:BABA) have struggled over the past 18 months as investors have tried to grapple with slowing growth across China’s economy and rising trade tensions between the U.S. and China, which threaten to accelerate the already naturally occurring China economic slowdown. Despite those big macroeconomic risks, the Alibaba stock growth narrative has remained resilient and healthy.
Source: Charles Chan Via Flickr
Indeed, the company has continued to fire off big revenue growth quarter after big revenue growth quarter.
As such, the bull-bear debate on BABA stock has smart people on both sides. Bulls are saying Alibaba remains a big growth company that is being unfairly knocked down by trade war risks, which the company has proven largely resilient to. Bears are saying Alibaba is a slowing growth company that will continue to slow as those trade war risks build up.
I think the bulls are right on this one, for three big reasons:
Alibaba is a high-quality growth story that has enough secular growth tailwinds behind it to offset the mildly slowing economic expansion in China. The economic slowdown in China is overstated, and China’s digital economy is still rapidly expanding. Alibaba stock is far too cheap considering its robust long term growth prospects.
All in all, the bull thesis on BABA stock at this point in time looks pretty compelling. You have a high-quality growth stock, at the epicenter of a secular growth market, trading at a discounted valuation because of overstated slowdown concerns. That combination ultimately makes BABA stock look like a good buy here and now.
Alibaba Stock and Quality Growth
First, and foremost, Alibaba is a high-quality growth story that has enough secular growth tailwinds behind it to offset the mildly slowing economic expansion in China.
For all intents and purposes, Alibaba is the heartbeat of China’s digital economy. The company operates the country’s largest e-commerce platform, as well as the country’s largest cloud business. That puts Alibaba at the intersection of two huge secular growth tailwinds – the rapid migration of commerce from the physical to digital channel, and the rapid migration of enterprise workloads from on-premise to cloud solutions.
Those two secular growth tailwinds have been enough to offset the mildly slowing economic expansion in China. Although China’s economy grew by just 6.6% in 2018 (the lowest rate in 28 years), Alibaba reported revenue growth last year and last quarter of over 50%. For the past several quarters, revenue growth has hovered in the 50-60% range. Thus, despite the slowing economic expansion in China, Alibaba has maintained its red hot growth trajectory.
Net-net, it’s safe to say that Alibaba is supported by secular tailwinds strong enough to keep this company on a winning trajectory for the foreseeable future.
China’s Digital Economy Is Still Rapidly Expanding
Second, it’s equally important to understand that China economic slowdown concerns are broadly overstated and that China’s digital economy is still rapidly expanding.
This starts with understanding that China’s economy is slowing from a sky-high growth pace. China’s economy did grow at its slowest pace in 28 years last year. But, the GDP growth rate was still 6.6%. The U.S. economy hasn’t printed a GDP growth rate above 6% since 1984. In other words, while China’s economy is slowing, it’s still growing at what would be a 35-year high rate for the U.S.
Further, China’s digital and consumer economies still remain hugely under-penetrated relative to the digital and consumer economies of developed countries. China’s GDP per capita, income per capita, and expenditures per capita are all just a fraction of what they are in developed countries like Germany, the UK, and the U.S.
By a fraction, I mean 10-25%, so very small relatively speaking. Further, China’s internet penetration rate is just 60%. Across North America and Europe, internet penetration rates are closing in on 90%.
Broadly, then, China’s digital and consumer economies remain hugely under-penetrated and have a long runway ahead to keep expanding. That’s why China’s ecommerce sales are expected to rise at a 15%-plus rate for the next several years. Alibaba is the heartbeat of that ecommerce market, and as such, finds itself at the epicenter of a still red-hot secular growth market.
Alibaba Stock Is Too Cheap
Third, it’s important to understand just how cheap BABA stock is relative to its long term growth potential.
Alibaba is a 50%-plus revenue growth company. Across the entire China internet landscape, you’d be hard pressed to find a company that has consistently grown revenues at a 50%-plus pace for the past several quarters.
The only other name that comes to mind is Bilibili (NASDAQ:BILI). The difference? Bilibili is expected to do revenues of less than $1 billion this year. Alibaba’s projected sales this year measure over $70 billion.
Thus, Alibaba is an unparalleled combination of big growth and big size. This big growth should persist given the company’s secular growth ecommerce and cloud tailwinds. Also, Alibaba is at the epicenter of the rapidly expanding China digital economy.
Margins are starting to stabilize after several quarters of compression. Big growth-related investments are fading out and paying off. This dynamic will persist. Continued big revenue growth over the next several years should be accompanied by healthy margin expansion.
Net-net, I see Alibaba as a 20% revenue grower over the next several years, with profit margins that should gradually expand from today’s depressed base. Ultimately, that paves a visible pathway for EPS to run towards $20 by fiscal 2026.
Based on a market average 16 forward multiple, that equates to a fiscal 2025 price target for Alibaba stock of $320. Discounted back by 10% per year, that implies a fundamentally supported fiscal 2020 price target of roughly $200.
Bottom Line on Alibaba Stock
Alibaba is a high-quality growth story at the epicenter of a secular growth market. That positioning gives the company tremendous long term profit growth potential. Alibaba stock presently trades at a discount to that big profit growth potential.
The result? Big growth will eventually and inevitably converge on a discounted valuation. When it does, BABA stock will fly towards $200.
As of this writing, Luke Lango was long BABA and BILI.
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