Alibaba: Weak Quarterly Results, But Accelerated Buyback Is Bullish

Summary

In Q2 FY2022, Alibaba reported minor misses on both top and bottom lines as revenue growth decelerated while margins came under pressure due to increased investments.

Alibaba is finally flexing its financial muscle by accelerating stock buybacks under its share repurchase program, instilling a floor on the stock.

Due to regulatory risks, Alibaba remains a tricky bet. However, the risk/reward is very favorable for long-term investors.

I rate Alibaba a buy at $143.

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David Becker/Getty Images News Introduction

For Q2 FY2022 , Alibaba ( BABA ) reported misses on both top and bottom lines while reducing revenue growth guidance for the rest of this fiscal year. After such a bad print, the stock tanked 12% in a single session. However, I think this sell-off is a good buying opportunity for long-term investors. In today’s article, we will dissect Alibaba’s quarterly report and try to understand its long-term implications on the company’s future. Furthermore, we will determine Alibaba’s fair value and expected return and discuss some of the risks associated with investing in Alibaba. Analyzing Alibaba’s Q2 FY2022 Results

In Q2, Alibaba’s revenue came in slightly short of expectations at $31.1B (up 29% y/y). However, user growth of 62M (up ~5% q/q) was quite impressive. Due to the consolidation of Sun Art and other significant strategic investments, Alibaba’s profitability (as measured by adjusted EBITA) dropped by 32% y/y. Furthermore, Alibaba’s management cut revenue guidance for the rest of this year due to slowing consumption in China. On first viewing, Alibaba’s numbers look weak, but let’s dig a little bit deeper. In 2020 and early 2021, the coronavirus pandemic led to a boom in global e-commerce, and Alibaba was a natural beneficiary. However, as the effects of the pandemic moderate, e-commerce sales growth rates have been moderating. As a result, Alibaba’s core e-commerce revenue growth has been decelerating in FY2022. On a positive note, Alibaba’s Cloud business continues to grow rapidly (up 33% y/y) at scale (Q2 revenue: $3.1B). In Q2, Alibaba’s gross margins declined by 900 bps y/y as the cost of revenue increased from 54% to 63%. Furthermore, strategic investments of ~$2.95B in new retail businesses, Taobao Deals, Lazada, and other business segments led to a 34% y/y drop in Alibaba’s adj. EBITA (profitability). I think that Alibaba’s management is looking to drive future revenue growth through reinvestments in key areas of its business. Without these investments, Alibaba’s adjusted EBITA would have remained steady at ~$8.1B. Hence, Alibaba’s business fundamentals are still looking strong. In a nutshell, Alibaba’s balance sheet is a fortress. The company has ~$66B of cash and short-term investments on its balance sheet. With tangible assets of ~$220B and total liabilities of ~$96B, Alibaba has ample liquidity, and the bankruptcy risk is minimal. In Q2, Alibaba managed to generate free cash flows of $3.45B (down -45% y/y) on operating cash flows of $5.5B (down -34% y/y). The free cash flows were depressed due to increased investments and could have been closer to $5B if the management had opted to optimize for FCF. With margin pressures expected to last throughout the rest of this year, I think Alibaba’s free cash flow generation will remain disrupted for the time being. However, we may see a recovery in FCF margins by FY2023. In the long run, I expect Alibaba’s FCF margin to expand up to 25% (with higher-margin businesses making up a more significant portion of total revenues). Over the years, Alibaba has generally utilized its free cash flows to reinvest in its business or make key strategic investments in companies like Ant Financial, Lazada, etc. My point is that Alibaba has shied away from making big stock repurchases. However, in Q2, Alibaba bought back ~26.9M ADSs for $5.1B as its stock has gotten significantly undervalued (after dropping by more than 50% in the last year or so). With more than $65B of cash and short-term investments on its balance sheet and robust cash flow generation of ~$20B per year, Alibaba has ample firepower to execute more such accelerated stock buybacks over coming quarters to support its stock.

According to consensus analyst estimates, Alibaba’s annual revenue could grow from $140B to $240B over the next three years. As margin pressures cool off, Alibaba’s free cash flow margin will move higher. From a long-term perspective, Alibaba’s business fundamentals are sound.

Source: Seeking Alpha

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