Alibaba Stock Is Down 70% From Highs, But Its AI Push Is Yielding Results

Last year, Alibaba’s cloud business experienced a slowdown as the demand for computing power related to remote work, remote education, and video streaming declined after the COVID-19 lockdowns ended. However, the company is now seeing a surge in demand for its AI offerings with AI product revenue continuing to grow at triple-digit rates year-on-year in Q1 FY’25. The company indicated that the number of paying customers using Alibaba Cloud’s AI platform rose 200% quarter-over-quarter.  Alibaba has focused on developing open-source AI large language models, giving developers more control to build their solutions using Alibaba’s models. This approach could also encourage them to use Alibaba’s cloud services to deploy these models. Large language models, which are trained on vast amounts of data, serve as the foundation for AI applications including chatbots such as ChatGPT. Alibaba is seen as a leader of sorts in AI model development in China. In fact, the company’s Qwen large language model has outperformed OpenAI’s GPT-4 in certain areas, such as language and creative capabilities, according to OpenCompass.

Operating profits for Alibaba’s Cloud Intelligence group rose by roughly 155% year-over-year to $322 million over Q1 FY’25. Profitability for the segment could continue to improve, as  Alibaba has been looking to reduce lower-margin projects in the cloud business while seeing a higher mix of artificial intelligence-related products. Although the cloud and AI business currently accounts for just about 11% of Alibaba’s revenues, the business’s faster growth and more positive margin trend could help to change the narrative around Alibaba stock.

Looking over a longer period, BABA stock has suffered a sharp decline of almost 70% from levels of $235 in early January 2021 to around $80 now, vs. an increase of about 50% for the S&P 500 over this roughly 3-year period. Notably, BABA stock has underperformed the broader market in each of the last 4 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 IPAR, PG, and KO, 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 overall valuation is also compelling. At the current market price of about $81 per share, BABA stock trades at just about 10x forward earnings. This is a much lower multiple compared to U.S. e-commerce behemoth Amazon, which trades at roughly 37x forward earnings, with only marginally higher near-term revenue growth projections. 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.  We estimate Alibaba’s valuation at about $106 per share – indicating a 30% upside from the market price of about $81 per share.  See our analysis of Alibaba revenues for more details on how Alibaba’s revenues are likely to trend.

[1] Returns as of 8/28/2024
[2] Cumulative total returns since the end of 2016