Shares of Alibaba Group Holding Ltd. (BABA, Financial) declined more than 8% in July after Chinese regulators tightened their grip on tech titans on account of anticompetitive practices and data security issues. A $2.8 billion fine levied by China's State Administration for Market Regulation under its Anti-Monopoly Law had a significant impact on the company's fiscal fourth-quarter 2021 earnings.
Regardless, Alibaba's outstanding operating performance has persisted, with the company's core business growing at a fast pace while retaining solid profitability. On Aug. 3, the company reported earnings of 16.60 yuan ($2.49) per share for the first quarter of fiscal 2022, exceeding analysts' expectations of 14.29 yuan per share. Revenue fell short of expectations, but grew more than 33% year over year, indicating the company is still growing in leaps and bounds.
The strong financial performance has failed to lift Alibaba shares higher in the recent past as investor focus has been fixed on the regulatory crackdown on Chinese tech companies. Miller Value Partners (Trades, Portfolio), led by investing guru Bill Miller, believes Alibaba is being unduly punished for regulatory scrutiny, but noted the worst is over for the company. In a letter to shareholders sent on Aug. 3, portfolio manager Samantha McLemore wrote:
“Alibaba, one of our largest growth holdings, exemplifies our approach here. The stock is down 35% from its highs hit in October 2020 primarily on fears regarding China’s regulatory crackdown. New headlines surface daily on the aggressive new approach by the Chinese government. We believe the worst is behind Alibaba. It has already been fined and agreed to changes in how it operates. The government’s focus has shifted elsewhere, most recently to Didi who just barely IPO’d. Recent press reports suggest the government is partnering with Alibaba to purchase a stake in troubled Suning.com indicating BABA could be back in the good graces of the government. These concerns have depressed expectations creating a divergence between those and what we believe are very strong fundamentals.”
Alibaba is valued at a forward price-earnings ratio of 20, which makes the company one of the most cheaply valued global tech giants today. From a valuation perspective, it is among the very few profitable tech companies that are trading at a reasonable price.
Earnings recap and the outlook for Alibaba
Alibaba reported 206 billion yuan in revenue, aided by the strong growth of its Chinese e-commerce business. Net income came in at 43.4 billion yuan, up 10% year over year. Global annual active consumers across the Alibaba ecosystem reached 1.18 billion, an increase of 45 million from the previous quarter.
Exhibit 1: Segment revenue
The consumer segment climbed 35% year over year, driven by the growth of the online physical goods segment of its retail platform, higher revenue from new monetization formats such as recommendation fees and an increase in the average unit price per click in search monetization. Other retail revenue in China increased 82% year over year as well, owing to the consolidation of Sun Art and considerable growth from Tmall Supermarket and Hema. In its China retail marketplaces, the company continues to make strategic investments to improve the consumer experience and to support merchant operations. Taobao Deals and Idle Fish continued to record robust user growth as well, boosting revenue.
The digital, media and entertainment segment's revenue grew 15% year over year, driven by the increase in revenue from Youku, Alibaba Pictures and other entertainment businesses. The cloud computing segment, on the other hand, reported 29% year-over-year growth in revenue, but growth slowed from the previous quarter due to a decline in sales since an unnamed top customer stopped using the overseas cloud services for their international business due to non-product related issues.
The company expects to generate over 930 billion yuan in revenue for fiscal 2022. Commenting on the quarterly performance and the outlook for the company, Chief Financial Officer Maggie Wu said:
“Number one, our guidance for the fiscal year remains unchanged. Number two, our investments in new strategic growth areas remain on target, and all the businesses we have invested are showing rapid growth. In the coming quarters, we'll continue to invest additional capital into programs that support our merchants and developing new businesses in strategic growth areas that will help us increase consumer wallet share and penetrate into new addressable markets. Our strong profit and cash flow generation capability gives us the internal resources to focus on long-term value creation. Number three, we are increasing our share repurchase program from USD 10 billion to USD 15 billion. This is the largest share repurchase program in the company's history because we are confident of our long-term growth prospects.”
For the quarter ended June 30, net cash provided by operating activities came in at 33 billion yuan and free cash flow was 20.6 billion yuan. Both metrics saw a decline in comparison to the previous year as the company had to use a large amount of cash to settle penalties imposed by Chinese regulators. Commenting on investor concerns related to regulatory pressure on the company, CEO Daniel Zhang said:
“Other than the update on our business side this quarter, I believe our investors will be even more focused on the recent regulatory change in the China Internet industry and expected impact on Alibaba. We are in the process of studying the regulatory requirements, evaluating the potential impacts on our relevant businesses, and we will respond positively with actions. We believe all these new regulations aim to foster the healthy development of the Internet industry over the long run. In the context of China's economic growth and livelihood improvement, this is consistent with Alibaba's long-term mission and vision to serve SMEs with digital technology, to serve the underprivileged groups, and to serve our consumers' demand for a better life. We continue to stay optimistic about the long-term potential of China's economy and the long-term growth prospects of Alibaba. We will fulfill our responsibilities as a platform in accordance with the regulatory requirements and continue to carry out our commitment to be a good company that creates long-term value for the society in China and globally.”
Alibaba is an e-commerce giant with an outstanding earnings track record. It will continue to play a key role in supporting China’s economic growth, benefiting from digitalization efforts carried out by both the government and private agencies. The company has a long runway for growth, especially in the cloud computing industry, and Chinese policymakers are highly unlikely to drag legal battles out extensively as it would not help the country’s mission to become a global leader in technology.
Takeaway
Alibaba shares have been punished in the market because of its troubles with regulators, and this short-termism has created a good opportunity for bargain hunters. The regulatory crackdown will eventually come to an end, by which time the company will resume its growth story. Opportunistically investing in the stock today could pave the way for multibagger returns in the next decade.
