Alibaba (BABA) yesterday presented a chart of mixed results for the quarter ending in December. The third quarter showed continued headwinds to revenue from Alibaba’s domestic business, which comes as no surprise. Alibaba, however, reported better-than-expected adjusted earnings per share, indicating that investors’ concerns about Alibaba’s business are overblown. Free cash flow, despite declining year over year, has remained strong and I think Alibaba’s valuation based on free cash flow and earnings doesn’t make sense at this time. !
Mixed revenue chart for Q3’22
Expectations for Alibaba’s third-quarter earnings map were very low due to tough retail sales in China and earlier warnings of slowing revenue growth. In the third quarter, Alibaba generated revenue of 242.6 billion Chinese yuan, or $38.1 billion. The reported revenue implies revenue growth of just 10% year-over-year, which is the slowest rate at which Alibaba’s sales have grown since the company went public. in 2014. Forecasts were for 246.4 billion Chinese yuan or $39.0 billion. While Alibaba missed the top line prediction, adjusted earnings per share of 16.87 Chinese yuan ($2.65) beat the estimate of 16.18 Chinese yuan ($2.56). Alibaba’s EPS fell 23% year-over-year, less than expected.
With 10% year-over-year revenue growth in the third quarter, Alibaba’s business performance disappointed and the decline in sales growth was particularly severe in China. Alibaba’s business activities in China – according to Alibaba’s new reporting format – posted a growth of only 7% year-on-year to 172.2 billion Chinese yuan due to macroeconomic challenges in the Chinese economy. China’s business activities still account for 71% of Alibaba’s revenue base.
However, slowing growth in Alibaba’s China e-commerce business was partially offset by continued strength in the company’s international operations. Total international trade generated 18% year-on-year growth with Cainiao – Alibaba’s Logistics Company – also benefiting from a higher volume of shipments. Cainiao delivered 15% year-over-year revenue growth due to a larger operational footprint and heavy investments in shipping capacity.
Strong growth was also seen in Alibaba’s local consumer services segment, which includes all of the company’s on-demand delivery services. Revenue in this segment jumped 27% year-over-year due to strong customer adoption of local delivery options and massive gains in customer acquisition.
Customer acquisition has never been a real problem for Alibaba and the company has continued to add a significant number of new customers to its various product and service platforms over the past quarter. Alibaba added 42.7 million new customers to its platforms quarter over quarter and ended December with 1.28 billion active accounts. Year-over-year, Alibaba’s customer base grew at a rate of 19%.
Customer growth in local consumer services (17 million net additions in Q3 22) and international business (16 million net additions in Q3 22) was particularly pronounced. – which includes Alibaba’s e-commerce platforms Lazada in Southeast Asia, daraz in Pakistan and trendyol in Turkey. Local consumer services and international e-commerce are currently driving Alibaba’s active account and revenue growth and a rebound in e-commerce activity in China would likely lead to much stronger revenue growth for the main line of Alibaba in the future.
Based on free cash flow, Alibaba’s valuation may just be a bad joke
There’s been a lot of talk about Alibaba’s slowing revenue growth, so I’m not going to detail something that’s well understood. What matters more than revenue, however, is free cash flow, which receives surprisingly little attention in a market that has been put off by Chinese companies.
Alibaba’s free cash flow in the third quarter was 71.02 billion Chinese yuan, or $11.2 billion. The third quarter saw a 26% year-over-year decrease in free cash flow due to increased investment in account growth and Alibaba’s merchant network. But, eleven billion quarterly free cash flow is still a remarkable sum… which allows Alibaba to do a lot of things, including new investments in strategic growth areas such as logistics or the acquisition of stocks (undervalued). In the first nine months of fiscal 2022, Alibaba’s various businesses generated an aggregate of 113.9 billion Chinese yuan or $17.9 billion of free cash flow, which corresponds to a margin of free cash flow of 18%.
Alibaba’s free cash flow for the first nine months already exceeds my lofty free cash flow estimate of 100 billion Chinese yuan ($15.8 billion) for the full year 2022. I estimate that Alibaba, even with slower revenue growth, will be able to increase free cash flow by $2.5 billion to $3.0 billion per year going forward, primarily by due to high FCF margins. If we were to assume a 15% lower free cash flow margin, to account for growing risks in China’s e-commerce segment, then Alibaba, based on $135.4 billion revenue forecast for the fiscal 2022 and $159.1 billion in fiscal 2023, could see free cash flow of approximately $20.3 billion (fiscal 2022) and $23.9 billion (fiscal 2023).
BABA initially fell towards $100 yesterday, but quickly recovered during the day…and they ended the day almost where they started at around $109.
Alibaba shares are incredibly cheap based on free cash flow and earnings. With free cash flow expected to be close to $23.9 billion (FY2023), Alibaba shares have a P-FCF ratio of 12X. ‘Alibaba only to business revenue growth.
Based on earnings, Alibaba is also a screaming buy (PE ratio of 11.8X).
Risks with Alibaba
Political risks have diminished lately, macroeconomic and revenue risks in Alibaba’s domestic e-commerce segment have increased. I think the slowdown in e-commerce business in China is temporary. In the meantime, Alibaba’s other businesses are doing reasonably well, and I’m particularly confident in the logistics business that Alibaba is looking to vertically integrate into its other e-commerce operations. The risks to Alibaba’s free cash flow are low as far as I can tell and Alibaba should be able to significantly increase its FCF going forward, even if revenue growth slows. Alibaba’s low valuation, relative to free cash flow, is probably the best reason to invest in Chinese e-commerce right now. However, a prolonged downturn in e-commerce will likely pose an ongoing risk to Alibaba and its stocks.
Alibaba presented a mixed earnings card yesterday, but it was far from the terrible record investors expected. Alibaba’s strong free cash flow suggests that the market may have become too bearish on Alibaba’s business prospects, especially in the international e-commerce market and the local delivery sector in which Alibaba crushes it. currently. Based on Alibaba’s actual free cash flow generation, the company’s valuation might be the biggest joke of the year!