Alibaba is my largest position. Here is why.
Opdateret: 19. feb.
Fiscal 2022 was a tough year for Alibaba. It all started in the end of 2020 with the postponed Ant IPO, and since then we have seen several new regulations in China, a fear of Alibaba and other Chinese companies being delisted from the U.S. stock exchange, rumors that the VIE structure would be banned and a whole lot of negative sentiment.
This is not a financial advice. I am not a financial advisor and I only do these post in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.
Since I have attended the workshop with Phil Town, I have decided to change the layout of my analyses a bit. I will do some more calculations and also briefly go through why the company has meaning to me. I have changed the format of the analysis a bit to try to make it shorter and with less numbers. If you want to read more about how I evaluate a company, please go to "MY STRATEGY" on my website.
For full disclosure, I should mention that Alibaba is my largest position and has been for a while. I will try to stay unbiased through the analysis, but you should be aware that a large chunk of my portfolio is invested in Alibaba. Furthermore, Alibaba is a huge company with all sorts of business. Hence, it won't be possible to get into every part of their business, as the analysis will end up being too long. So, if there are parts of Alibaba that you really like that I don't touch upon, I apologize in advance. I should also mention that I continue to buy Alibaba shares on the Hong Kong stock exchange every week now when I get paid my extra income. You can do it too, read more here.
Alibaba is described as a Chinese multinational technology company. It was founded in 1999 by Jack Ma and 17 other people and started as an online platform to help Chinese small businesses and exporters find business opportunities in the world. It has still grown to be a very large company that is probably mostly known for their e-commerce, while they also have other sorts of businesses. The vast number of businesses makes it overwhelming to even start to understand the business, and even more to write an analysis. Luckily, Alibaba segmented all their businesses into five different segments at the last investor days. These segments are China Commerce, International Commerce, Local Consumer Services, Cainiao (logistics) and Cloud. Alibaba is most known for their Chinese Commerce sector, which includes Taobao and Tmall, which is also what gives Alibaba their brand moat. Nevertheless, they are also known for their cloud business, where they are the third largest in the world. I will investigate some of the segments later in this analysis.
Their CEO is Daniel Zhang. He became the CEO in 2015 but has been part of the Alibaba Group since 2007, where he became the CFO of Taobao. Prior to joining Alibaba, he served as a CFO at a Chinese online game developer and operator called Shanda Interactive Entertainment Limited that was then listed on Nasdaq. Besides being the CEO and Chairman of Alibaba, he also serves on the board of Weibo. He is educated from Shanghai University of Finance and Economics, where he received a bachelor's degree. He is credited for being the one responsible for turning Singles' Day into a 24-hour shopping festival, which he did a very good job on, as it is now the largest physical retail and online shopping day in the world. When asked about his thoughts on leadership and his own experiences in switching from being a CFO to CEO, he mentioned some interesting observations, saying that as a CEO you sometimes need to make imperfect decisions as in the world of innovations not everything is accountable. He also mentions that in his role as a CEO of Alibaba, he cannot do everything himself, so he needs to enable his partners to become better leaders, let them assemble their teams and make their own imperfect decisions. Furthermore, when previously asked what define a good leader, it isn't about technical competency, as it is a basic requirement. Instead, what define a good later is wanting other people to be better than yourself. Personally, I really like his modern take on leadership, and combined with his credentials, I have faith in Daniel Zhang being able to move Alibaba forward.
I believe that Alibaba has a brand moat. I also regard the management highly and believe they will grow Alibaba moving forward. Now, let us investigate the numbers to see if Alibaba lives up to our requirements for a strong moat. In case you want an explanation about what the numbers are, you can have a look at "MY STRATEGY" on the website.
The first and most important number we will investigate is the return on investment capital, also known as ROIC. We want to see 10 years of history and we want the numbers to be above 10 % in all the years. Alibaba didn't IPO until 2014, so I do not have the numbers for the first years. Looking at the other numbers Alibaba has delivered the desired numbers in all years except for fiscal 2022, which was very hard to Alibaba due to regulations and COVID lockdowns. Hopefully, it is an outlier and Alibaba will be back consistently delivering ROIC above 10 % moving forward.
The next numbers are the book value + dividend. In my old format this was known as the equity growth rate. It was the most important of the four growth rates I used to use in my analyses, which is why I will continue to use it moving forward. As you are used to see the numbers in percentage, I have decided to share both the numbers and the percentage growth year over year. Alibaba delivers once again as they have grown their book value ever single year from their IPO, even in fiscal 2022, which was a very challenging year for Alibaba. Hopefully, the trend will continue moving forward.
Finally, we investigate the free cash flow. In short, free cash flow is the cash a company generates after it has paid for operating expenses and capital expenditures. Levered free cash flow is the amount of money a company has left remaining after paying all of its financial obligations, I use the margin for it to make more sense. Free cash flow yield is the free cash flow per share a company is expected to earn against its market value per share. It is the same pattern as we saw with the ROIC. Alibaba has delivered great numbers historically, while fiscal 2022 was challenging for Alibaba. Before the pandemic levered free cash flow was starting to decrease as the company was maturing. However, it may change as they build their cloud business, and delivering a levered free cash flow of more than 5 % isn't too shabby.
Another important thing to investigate is debt, and we want to see if a business has a reasonable debt that can be paid off within 3 years. We do so by dividing the total long-term debt by current earnings. Having done the calculations on Alibaba, they show that Alibaba can pay off their debt in 2,14 years. It is way below the requirement of 3 years, which means that debt isn't an issue if I should choose to invest in the company.
Like with all other companies, there are some risks if you choose to invest in Alibaba. In their investor days in December 2021, the management mentioned different market uncertainties both in the short-term and mid to long-term. Of short-term risks they mentioned impact of COVID-19 on consumption growth, global supply chain challenges, and regulatory policies. There are still a lot of uncertainties when it comes to COVID-19 in China, and how it will affect consumption growth in the short-term, and I don't think anyone can predict how it will end. Supply chain challenges is an issue for all companies, and unfortunately, we don't know for how long it will last. Regarding the regulatory policies, I will write about that in the next paragraph. Of mid to long-term risks, they mention fast-changing consumer demands and market competition. I will elaborate a bit about that later.
The regulatory policies are the primary reason why the stock price of Alibaba has lost more than 50 % from its all-time high in October 2020. By regulatory policies we don't have to look only at China but also at the United States. We have heard a lot of talk about the U.S. wants to ban Chinese companies from their stock exchange and ban American citizens from investing in the companies. I will try not to go too much in details but there are 3 things you need to be aware of, when it comes to the risk of the U.S. delisting Chinese companies and ban Americans from investing in Chinese companies. There are two executive orders made by Donald Trump, the first is the executive order on addressing the threat from securities investments that finance communist Chinese military companies. It doesn't seem plausible that a company such as Alibaba will fall under this executive order, as no e-commerce companies has made the list made by the U.S. Department of Defense. The second is the executive order addressing the threat posed by applications and other software developed or controlled by Chinese companies. This is a larger threat, and it was this executive order that was used to blacklist Alipay. Nothing suggests that this executive order will be used, especially because it was made by Donald Trump and not Joe Biden but to me, it is the largest risk coming from the U.S. It also means that I'm not too worried about the Holding Foreign Companies Accountable Act, which is what get the most publicity in western media. The act means that SEC can request to inspect audit papers for any company that is listed in the U.S. If they do not receive the audit papers within 3 years from them asking, the company will get delisted. Luckily, we have seen some good news from the CSRC (the Chinese SEC) regarding the potential problem in SEC accessing the audit papers. Just before New Year's, the CSRC stated: "China will actively promote cross-border audit and regulatory cooperation. In today's highly globalized capital markets, there is a greater need for national regulators to strengthen regulatory cooperation and policy communication". Since then, we have had some encouraging comments from the CSRC regarding coming to an agreement with the SEC/PCAOB. However, this issue still must be fixed. And it needs to be fixed soon, as the America Competes Act will cut the grace period that Chinese companies have to comply with audit inspections from 3 years to 2 years. The America Competes Act has passed both the House and the Senate and is now in the "resolving differences" phase before it will be signed by President Biden. We also have regulatory policies in China that needs to be addressed. One is the potential banning of the VIE structure. I never saw this as a real threat, as I see no reason for that to happen, and it seems like it won't happen as CSRC has proposed some draft regulations for overseas listing. If companies follow these regulations, they will be approved, and we won't see another DIDI scandal happening. Regarding the draft regulations CSRC stated: "Companies with VIE structure that meets the compliance requirements can go overseas for listing". It surely doesn't sound like they want to ban it. We also have the various regulations in China, which is what has built the negative sentiment towards China, and while some people believe they are to destroy Chinese companies, I think differently. I believe you need regulations for it to be sustainable, so does the CSRC, which stated: "Opening up to the outside world is China's basic national policy and that the purpose of improving the regulatory regime is to promote a healthier, more sustainable and longer-term development, rather than policy tightening. Furthermore, we have had various Chinese officials such as Premier Li Keqian endorsing the platform economy. The $15,5 billion donation to common prosperity. It could be to get in the good graces of the Chinese Government but according to Daniel Zhang it will boost common prosperity, which will boost the company's future business. Alibaba was probably nudged into the donation, but I see the point of Daniel Zhang, and I don't think it necessarily will be a bad thing.
Let's move on to the potential of Alibaba. It is no secret that revenue growth has slowed down a bit but interestingly, the revenue is more diversified now, as more of the revenue comes from international commerce and cloud. They believe that international commerce will continue to grow, as the e-commerce penetration is very low in both Southeast Asia and in the EMEA region. Their Turkish e-commerce platform "Trendyol" grew 48 % year over year but due to the depreciation of the Turkish lira it hasn't shown in their balance sheet. Furthermore, management will launch "Lazada" in Europe, where it will target European vendors. Management hopes to gain market shares that way. Their cloud business is also expected to grow moving forward. During their investor days they mentioned that the Chinese cloud market is expected to grow at a 37 % CAGR compared to 21 % CAGR in the U.S. As mentioned previously, Alibaba is already the largest cloud company in China, and they will get their share of the growth. Their cloud business had its first profitable quarter in the first quarter of 2022, and it is also worth noting that it is a high margin business that should benefit Alibaba in the long run. Still potential in Chinese commerce. Alibaba already has more than 1 billion users in China, but it doesn't mean they cannot grow their revenue. Alibaba believes they can grow in less developed areas, while they also expect increased spending from their youngers users as they grow older.
All right, we have gone through the numbers, risks, and potential regarding Alibaba and now it is time for us to calculate a price. To calculate price, we will need numbers that I have explained in the "MY STRATEGY" section of the website. I do not want to go through the whole calculation here. I chose to use an EPS of 5,1, which is the current one. It is way lower than 2019 (7,9) and 2020 (8,36) but higher than 2021 (3,6). I chose an Estimated future EPS growth rate of 15 (which is the highest possible I use but below Alibaba's own estimations), Estimated future PE 30 (which the double of the growth rate, as the historically PE for Alibaba has been higher) and we already have the minimum acceptable return rate on 15 %. Doing the calculations by using the formula I described in "MY STRATEGY", we come up with the sticker price (some call it fair value or intrinsic value) of $122,88, and we want to have a margin of safety on 50 % , so we will divide it by 2 meaning that we want to buy Alibaba at price of $61,44 (or lower obviously), if we use the Margin of Safety price. (If we made the calculations with the EPS from 2020 of 8,36, the Margin of Safety price would be $100,32)
Our second way to calculate a buy price is the TEN CAP price, which is also explained at "MY STRATEGY". To do so, we need some numbers from their financial statements, keep in mind that all numbers are in millions. The Operating Cash Flow last year was 22.515. The Capital Expenditures was 8.408. I tried to look through their annual report to see, how much of the capital expenditures were used on maintenance. I couldn't find it though, so as a rule of thumb, you expect 70 % of the capital expenditures to be used on maintenance, meaning we will use 5.885,6 in our further calculations. The Tax Provision was 19.603. We have 21.357,323 outstanding shares. Hence, the calculation will be like this: (22.515 - 5.885,6 + 19.603) / 21.357,323 x 10 = $16,96 in TEN CAP price. (Once again it is important to remember that fiscal 2022 was bad for Alibaba. Doing the calculations on fiscal 2021 the TEN CAP price would have been $125,51)
The other calculation I will make is the PAYBACK TIME. It is also described in "MY STRATEGY". With the Free Cash Flow Per Share at 5,35 and a growth rate of 15 %, if you want your purchase back in 8 years, the PAYBACK TIME price is $84,53. (if we made the calculations with the free cash flow per share of 10,71 as it was in 2021, the PAYBACK price would be $169,07).
I believe that Alibaba is a fantastic company. It is a company that delivers a high ROIC and large growth in all the areas I look at. The company still have plenty of areas to grow in and the focus will be on international commerce and cloud moving forward. I believe they have the right management, and I'm very confident in them being able to move Alibaba forward. Yes, there are some risks regarding Alibaba and other Chinese companies. I have tried my best do describe these risks in a long paragraph in this analysis. As mentioned earlier, Alibaba is my largest position, and I don't believe that Alibaba should trade at these levels, which they wouldn't if it wasn't for the negative sentiment. This sentiment can continue for a long time, and it is impossible to know when the sentiment will change, so you will need to be able to stomach that, together with potential delisting risks, if you invest in Alibaba. I wouldn't focus too much on the calculations in this analysis as fiscal 2022 was tough on Alibaba because of regulations and lockdowns. If you think that things will normalize in China, I believe Alibaba is a great buy around $100.
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