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Alibaba: Undervalued Earnings Potential And Recent Investments

Alibaba offers considerable upward potential, stock price target $104.50.

Sales and earnings offer high growth and profitability potential.

Recent stock market development has led to an undervalued Alibaba stock price.

The investment is characterized by rather low risk compared to the potential return.

Thesis

Alibaba (NYSE:BABA) - with a market capitalization of $172.629 billion (Oct. 10, 2015) - is an e-commerce provider which is currently trading at $68.71 (Oct. 10, 2015). I believe the stock is trading under its fair value based on unfavorable market volatility, the exit of short-term investors (such as asset managers focusing on quarterly results) and prominent investors such as George Soros recently turning down their Alibaba stake. Alibaba's core and non-core business activities as well as recent minority stake investments and acquisitions have lucrative growth and earnings prospects in the promising Chinese and East Asian region, which are not fairly considered in the current valuation.

Market Analysis/Rising Opportunities

The e-commerce industry has grown significantly in the recent past based on a consumer preference shift from brick-and-mortar shopping toward online retailing. Customers find it more convenient to order online and get the goods delivered to their homes/offices. Furthermore, it's fairly easy to reach a targeted group via the Internet. Less capital is required to store goods and the usual rent paid in the brick-and-mortar retail business also is basically non-existent. Therefore, growth rates and potential earnings margins are far more promising in the e-commerce business compared to the common retail business. e-commerce sales in 2014 totaled $1.3 trillion and is expected to grow to $2.5 billion in 2018. Also, China and East Asia are blessed with above average GDP growth, a rising middle-income class as well as a major shift toward technology and e-commerce industries. China's GDP on a dollar basis is estimated to grow on average 4.5-5% P.A. until 2030.

Alibaba is notably well-positioned to benefit from the estimated underlying market and economic conditions in East Asia, and China in particular. Furthermore, there's an ongoing trend that e-commerce purchases are shifting from personal computers to smartphones. This can be considered as a challenge as it's currently difficult to earn a substantial rate with smartphone social media, internet and e-commerce. This can be seen by monetization rates of Alibaba and its respective competitors, which are substantially lower compared to the PC monetization rate.

However, Alibaba was able to increase its monetization rate continuously (except latest figures) from an initial 0.58% in Q1 FY14 to 1.96% in Q3 FY15, decreasing to 1.73% in Q4 FY15. However, it's important that the spring business is rather weak compared to the other quarters. I believe, since Alibaba invests large amounts into R&D to fund mobile software development to increase user experience while being able to increase monetization rate, that the company will be able to achieve a monetization rate between 2.5%-3.0% (including personal computer, where the monetization rate has been around 3% in the recent past).

Competitor Analysis

Based on the promising outlook of the e-commerce industry combined with rather low barriers to entry (no considerable inventory or facilities needed to start a simple online shop), especially in China, more and more competitors are entering the market to try to obtain market share from Alibaba, which has been the dominant player in the Chinese e-commerce market. However, there is a comparatively low amount of competitors with a similar scale like Alibaba. Global core competitors are arguably Amazon, eBay, and MercadoLibre, and the Chinese core competitors are Tencent, JD.com, and Vipshop.

At first glance, one would not define Tencent as a competitor. However, Tencent obtained patented technologies in e-commerce and online payment services. This, combined with the fact that Tencent serves a large customer base (QQ has a customer base of >830 million people, January 2015) with its services and that there have been rumors about a collaboration between JD.com and Tencent, makes the company a potential large competitor in the future.

Large global competitor. However, Amazon has not operated profitably in the recent past but is expected to break even this year (Forward P/E of 351 in FY15).

eBay has a market capitalization of $29.6 billion and is arguably the most comparable Western enterprise to Alibaba in China and Asia. However, eBay monetizes far more of its GMV (10.8%), proving that a high monetization rate is possible after a company has established in a particular sector and market.

In China, it's a fierce competitor with a...


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