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Alibaba: Unlocking Share Price Upside with a Winning Combination

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China-Based Internet Company Alibaba Debuts On New York Stock Exchange

Alibaba (NYSE:BABA) is set to release its FY 2024 Q2 earnings before the market opens on November 17th. Despite the ongoing macroeconomic challenges in China, I am optimistic about Alibaba’s earnings prospects for this quarter. A combination of factors, including a rise in consumer spending in China, increased enterprise traction within Alibaba Cloud, and progress in building a Gen AI product portfolio contribute to this positive outlook. When added to strong fundamentals and attractive valuations, we have a recipe for significant share price appreciation.

In preparation for the upcoming earnings release, I maintain my belief that Alibaba’s stock is significantly undervalued at below 10x EV/EBIT. With FY 2024 Q2 anticipated to be a strong performance, I expect the Chinese e-commerce giant to rally towards my target price of $150.56 per share.

It is worth noting that Alibaba’s shares have underperformed compared to U.S. competitor Amazon (AMZN) and the broader stock market. While BABA shares have declined by nearly 10%, Amazon and the S&P 500 (SP500) have experienced gains of approximately 8% and 49%, respectively, year to date.

Alibaba vs. Amazon vs. S&P500 YTD 2023 share price performance

Alibaba To Benefit from China’s Stabilizing Economy

China’s economic rebound is gaining momentum, with various indicators pointing to an uptick in both production and consumption. The purchasing managers’ index for China’s manufacturing sector returned to expansion territory in August and September 2023 after four consecutive months of negative growth. The government’s pro-growth policies, designed to support the private sector, revitalize the capital market, and expand strategic emerging industries in Cloud, silicon technology, and AI, have contributed to this positive trend. China’s economy grew at a rate of 5.2% in the nine months leading up to the end of September, putting the country on track to achieve its goal of approximately 5% growth for the year.

Although the property sector remains a concern, the government’s introduction of measures to boost housing demand, such as reducing down payments and easing mortgage regulations, provides optimism for the sector’s future.

Consumer sentiment is a significant macroeconomic tailwind for Alibaba. Retail sales of consumer goods increased by 4.6% year over year in August and showed further acceleration in September, reaching 5.5%. This positive momentum is expected to continue into the fourth quarter, driven by holiday-related spending and the upcoming “Double 11” online shopping festival in October.

China retail sales of consumer goods

Alibaba’s Cloud Business Set for Growth

U.S. tech giants, including Microsoft (MSFT), Google (GOOG), and Amazon (AMZN), reported strong growth in their cloud businesses in Q3. Alibaba, with a dominant 36% market share in China’s cloud market and an annual revenue run rate of $14 billion as of June 2023, is well-positioned to capitalize on the secular growth tailwind. While China’s cloud market is still nascent compared to the U.S., Alibaba’s infrastructure has tremendous upside potential.

In the June quarter, Alibaba expressed optimism about its cloud business, stating that they received strong demand for AI services on their cloud infrastructure. The opportunities for growth driven by AI services are just beginning, and Alibaba believes that AI will have a significant impact on all industries in the long term.

Alibaba Cloud made headlines when it announced its support for Meta’s open-source AI language model, Llama2. This move allows Chinese businesses to leverage AI technologies on Alibaba’s cloud platform, similar to AI chatbots like OpenAI’s ChatGPT and Google’s Bard. Furthermore, Alibaba introduced its AI tool, Tongyi Wanxiang, which can generate images from text prompts in English or Mandarin. Although in beta testing, this tool is expected to be accessible to enterprise customers in the coming months, further bolstering Alibaba’s position in AI.

Positive Shift in Analyst Sentiment

With the strong consumer sentiment in the e-commerce sector and the favorable tailwind for the cloud business, Alibaba’s FY 2024 Q2 reporting is poised to impress. Analyst forecasts indicate that Alibaba’s total sales for the September period will range from $29.426 billion to $32.74 billion, with an average estimate of approximately $30.94 billion. This suggests a nearly 7% year-over-year increase compared to the same quarter in 2022.

It is noteworthy that analyst consensus on Alibaba’s topline revenue has finally bottomed out after three years of declining sentiment. The first positive revisions in forecast trends signify a strengthening of sentiment among street analysts.

Seeking Alpha - Alibaba revenue projections

On the profitability front, analysts project a 15% year-over-year growth in EPS, with a consensus estimate of $2.08 (falling within a range of $1.71 to $2.30). After a period of sluggish performance, a double-digit earnings growth would significantly boost investor sentiment.

Seeking Alpha - Alibaba EPS projections

Investor Takeaway

Alibaba’s upcoming FY 2024 Q2 earnings release presents several reasons to be optimistic about the company’s performance. The strengthening Chinese economy, the cloud business’s potential, positive analyst sentiment, and anticipated growth in sales and EPS all contribute to this positive outlook. Given the undervalued stock with an EV/EBIT valuation below 10x, I reiterate my bullish recommendation on Alibaba with a target price of $150.56 per share.

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