BABA – What does the Future Hold?

We adjust all of our figures to show results and estimates in constant currency (6.35 USD/RMB).

This report was published by a junior research associate Bruce Zhang and overseen by Robin Manson-Hing. It is a preliminary view of Alibaba.

Over the last three years, Alibaba (BABA-NYSE) is generally highly correlated with the NASDAQ composite and other technology stocks, while trading at a beta of 2.5x. SImilar to the market, Alibaba’s share price has also pulled back. We take a closer look at Alibaba’s business and what the stock price might do in the near future.

In constant currency, sales growth was materially higher than reported last quarter –  Fiscal Q3/18 sales (December 31, 2017 quarter) were up 56% Y/Y to US$13.1 billion versus fiscal Q3/17’s sales growth of 54% Y/Y. However, on a constant currency basis at a rate of 6.35 RMB/USD, sales growth was actually up 62% Y/Y in fiscal Q3/18 versus 44% in fiscal Q3/17. We estimate pageviews of Tmall and Taobao were up only 13% Y/Y in fiscal Q3/18 versus up 20% Y/Y in fiscal Q3/17. This translates to Alibaba increasingly relying on inorganic growth. 

Source: Perspectec

Our belief that 2018 revenue growth will accelerate is being driven by:

1. The acquisitions of Intime in early 2017 and the opening up ~25 physical Hema supermarkets (most of the RMB 4.3 billion increase reported for ‘Other’)
2. The acquisition of Cainiao logistics services (RMB 3.9 billion)
3. Growth in its SMB Imports business AliExpress (RMB 2.3 billion)
4. Growth in its cloud computing businesses (RMB 1.8 billion)
5. China e-commerce cross-border sales have increased over 100% in 2017. Alibaba will increasingly benefit from this due to their acquisition of Lazda last year as well as through AliExpress.

EPS would have been inline using a normalized exchange rate in Q3/18 – BABA has slightly underperformed the NASDAQ Composite since reporting fiscal Q3/18 results. We believe this has been driven to some extent by EPS of $1.63 that was $0.04 short of consensus estimates. However, at our normalized exchange rate of 6.35, EPS would have been in-line at $1.67.

2018 Guidance does not clear up the EPS picture, which we believe will beat expectations in 2019 – While their full-year, mid-point revenue guidance growth estimate increased by 450 basis points to 55% to 56%, the market understandably is less clear on margins. Based on Alibaba’s trending operating margins, which they keep fairly consistent, we believe Alibaba is set to beat consensus EPS for fiscal 2019.

Catalysts:

Alibaba’s use of A.I. technology to analyze customers’ interests to make personal recommendations (target advertisement) continue to drive strong growth in user engagement, conversion

1) A.I. technology will help Alibaba’s consumer base grow at a rapid pace – We believe A.I. is a primary reason Alibaba saw an acceleration of 31 million mobile users compared to last quarter. Targeting advertisement decreased pageview, increased customers’ shopping efficiency and satisfaction.

Source: Perspectec

Source: Perspectec

– The average ad rate for FY 2018 Q1 to Q3 is $0.024 per PageView, a 33.3% increase compared to FY 2017 Q1 to Q3. Again we believe this is being driven by a more diverse A.I. technology covering 

2) Higher average online marketing service rate – The average ad rate for FY 2018 Q1 to Q3 was $0.024 per PageView, a 33.3% increase compared to FY 2017 Q1 to Q3. This is a direct result of their improved A.I. technology driven marketing service platform (Alimama.com), which combined their cloud computing services as a data-powered marketing technology platform to analyze their customer’s shopping behavior and video watching (Youku & Tudou). In return for more targeted marketing, BABA was able to charge higher fees to the merchants technology-driven marketing service platform (Alimama.com).

3) Their ‘New Retail’ strategy – Alibaba’s ‘New Retail’ strategy aims to combine online and offline retail. Alibaba has a three-pronged approach to achieve this strategy. First, Alibaba’s online shopping platform handles billions of transactions each month, providing Alibaba data of its customers buying behavior and markets trends. This info is used to give Alibaba’s offline stores data on product line demand. A.I. technology and cloud computing to Alibaba’s future revenue and operating costs but in the medium term, A.I. improvements would be expected to be a competitive advantage for their online and offline retail stores.Alibaba’s

4) China retail trends are Alibaba’s friend – The offline Chinese retail industry remains somewhat of a growth industry.

Source: National Bureau of Statistics of China, U.S. Census Bureau

China’s off-line retail market is growing at the rate of the U.S. e-commerce market at about 10% a year. More impressive is that e-commerce grew at 28% Y/Y in 2017 according to China. Perhaps most impressive of all is that cross-border China e-commerce was up 80% in 2017, as the Chinese market continues to open itself up to imports (up 116% in 2017). The import market could be a real growth driver for Tmall and Taobao in the future and is not something they have catered closely to.

Forecasting Revenue

China Commerce Retail (CCR) accounts for the biggest percentage of Alibaba’s revenue (>70%). 98% of CCR revenue in fiscal 2017 comes from online marketing services revenue and commission generated from Gross Merchandise Value (GMV) on Tmall. Marketing service pricing is not public, so we estimate what Alibaba’s CCR revenue is by looking at how much money was generated in the past by each pageview (pageview data is from iresearchchina.com). Historical rates and trends are used to forecast future ad rates and marketing service revenue. The difference between our estimate and the later actual reported revenue in fiscal Q3 was less than 5%.

Our estimate for fiscal Q4/18 CCR revenue is $6.006 billion (using a USD/CNY = 6.35)

Financial Expectations for the coming quarters and years:

Source: Perspectec

The Q3 revenue beat our estimate by 5%, primarily driven by an increase in international commerce retail (AliExpress). The international trade trend being a driver in the face of U.S. political talk. 

The strong revenue beat pushed BABA to raise their fiscal 2018 revenue expectations to 55% to 56% (previously 49% to 53%).

Our fiscal Q4 EPS estimate is $0.90 vs consensus $0.76. For fiscal year 2018, our EPS estimate is $4.38 vs consensus of $4.05. (Note: we use a USD/CNY exchange rate of 6.35)

Source: Yahoo Finance

We believe the key valuation metric to look at is the P/E ratio based how the stock has traded over the last few years. In the table above, we chose Amazon, Google and JD.com as comparables. Google’s primary revenue also comes from online marketing services. JD.com is the largest e-commerce company in China. As the chart above shows, Alibaba’s forward  EPS growth is the least aggressive and we believe 2018 EPS is very achievable.

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