Alibaba’s Q1 Preview: Navigating A Tough Chinese Economy

Chinese e-commerce and cloud behemoth Alibaba stock (NYSE:BABA) stock has been a weak performer this year, rising by just about 1% since early January. In comparison, its U.S.-based peer Amazon (NASDAQ:AMZN)  has gained 21% over the same period. Now Alibaba is expected to publish its Q1 FY’25 results in early August, reporting on a quarter that has seen mixed economic data from China and mounting competition from new e-commerce players. We project that Alibaba’s revenues will come in at about $34.5 billion for the quarter, while earnings are likely to come in at about $2.10 per share, slightly below last year’s numbers and roughly in line with consensus. So what are some of the trends that are likely to drive Alibaba’s earnings for the quarter?

China’s economic growth has been weak with GDP rising by just about 4.7% in the quarter that ended in June, down from 5.3% in the first quarter, as the country faces a downturn in the real estate market and a slow rebound from stringent Covid-19 lockdowns that ended over a year ago. Moreover, consumer spending and domestic consumption also remain weak in China. Retail sales recently fell to an 18-month low due to deflation, as businesses have been cutting prices while employers have been reducing salaries with unemployment among the youth remaining high at about 14% in May. This is likely to weigh on Alibaba’s e-commerce business for the quarter. Over Q4 FY’24, revenue from the company’s core Taobao and Tmall online marketplaces rose by just about 4% year on year to 93.2 billion yuan ($12.9 billion).  Alibaba has also been witnessing mounting competition in the e-commerce space with PDD, the owner of discount e-commerce platforms Pinduoduo and Temu, gaining share as Chinese consumers become more value-conscious due to a weak economy.

Alibaba’s cloud computing business has also seen growth cool off considerably, with revenue rising by just about 3% over the most recent quarter. The slowdown comes as demand for computing power relating to remote work, remote education, as well as video streaming eases following the Covid-19 lockdowns. That said, Alibaba has indicated that it was looking to reduce lower margin projects from the business while noting the growth of artificial intelligence-related products could help the business boost profitability going forward.

BABA stock has suffered a sharp decline of 65% from levels of $235 in early January 2021 to around $80 now, vs. an increase of about 45% for the S&P 500 over this roughly 3-year period. Notably, BABA stock has underperformed the broader market in each of the last 3 years. Returns for the stock were -49% in 2021, -26% in 2022, and -12% in 2023. In comparison, returns for the S&P 500 have been 27% in 2021, -19% in 2022, and 24% in 2023 – indicating that BABA underperformed the S&P in 2021, 2022, and 2023. In fact, consistently beating the S&P 500 – in good times and bad – has been difficult over recent years for individual stocks; for heavyweights in the Consumer Staples sector including WMT, PG, and COST, and even for the megacap stars GOOG, TSLA, and MSFT.

In contrast, the Trefis High Quality (HQ) Portfolio, with a collection of 30 stocks, has outperformed the S&P 500 each year over the same period. Why is that? As a group, HQ Portfolio stocks provided better returns with less risk versus the benchmark index; less of a roller-coaster ride as evident in HQ Portfolio performance metrics. Given the current uncertain macroeconomic environment with high oil prices and elevated interest rates, could BABA face a similar situation as it did in 2021, 2022, and 2023 and underperform the S&P over the next 12 months – or will it see a recovery?

Alibaba’s valuation is also compelling. At the current market price of about $79 per share, BABA stock trades at under 10x forward earnings, which is very fair in our view, given that the company is likely to see high single-digit growth levels over the next two fiscal years.  Alibaba has also been doubling down on its share repurchases, spending about $5.8 billion to buy back 77 million American depositary shares during the quarter ended in June 2024. Bloomberg also recently reported that Alibaba will increase merchant fees, which are the source of a bulk of its revenue. Alibaba’s overall valuation is much more favorable compared to U.S. e-commerce behemoth Amazon, which trades at roughly 42x forward earnings, with only marginally higher near-term revenue growth projections. We estimate Alibaba’s valuation at about $107 per share indicating a 36% upside from the market price of about $78 per share.  See our analysis of Alibaba revenues for more details on how Alibaba’s revenues are likely to trend.

[1] Returns as of 7/30/2024
[2] Cumulative total returns since the end of 2016

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