SINGAPORE (Dec 9): Our big bet on Alibaba Group Holding is starting to pay off. For much of the past two years, the stock performance has been lacklustre despite rising sales and profits. Investor sentiment was affected by worries over the worsening trade war between the US and China, the slowdown in the world’s second-largest economy and, to a certain extent, concerns over the Chinese government’s involvement/interference in the company. At the worst point of the trade spat, there was even talk of delisting Chinese stocks from the New York Stock Exchange.
Because of many of these reasons, its recent secondary listing on the Stock Exchange of Hong Kong (SEHK) was an important catalyst and turning point. The move brings Alibaba much closer to its home turf, where investors are not only familiar with its name but are most likely users and customers of its products and services.
About one-third of the US$14.6 billion ($19.9 billion) raised from the secondary listing came from Mainland Chinese funds, a growing capital pool. Insurance and mutual funds are expected to expand rapidly in Asia-Pacific, where savings rates are high.
Alibaba could join the benchmark Hang Seng index in 1Q2020 and be included in the China-Hong Kong stock connect programme — a collaboration between the Hong Kong, Shanghai and Shenzhen stock exchanges — by mid-2020. The trading link allows Chinese investors to buy shares on the SEHK through their local brokerages. All these, we believe, will gradually pare the prevailing risk discount on Alibaba shares and lift valuations.
Even after the recent rally, the stock is still trading at very attractive valuations. Its forward price-to-earnings ratio (PER) stands at less than 22 times, which is significantly lower than the 65 times for US-based Amazon.com. And it is growing much faster, with top- and bottom-line growth estimated at 25% to 35%.
Alibaba’s earnings results for 2QFY2020 ended Sept 30 handily beat market expectations for the fourth straight quarter. Revenue expanded 40% y-o-y to RMB119 billion (US$16.7 billion). Net profit was also sharply higher, thanks in part to one-off gains related to the swapping of an existing profit-sharing agreement for a 33% stake in Ant Financial. Excluding this, nonGAAP (generally accepted accounting principles) net income was 40% higher y-o-y at RMB32.75 billion (US$4.58 billion).
By comparison, Amazon’s revenue was up 24% y-o-y for the same quarter, to US$70 billion, while net profit stood at US$2.13 billion. In short, while Amazon’s sales are larger, Alibaba is much more profitable.
Alibaba is the only stock that has remained consistently in the Global Portfolio since its inception in December 2017. Our investment thesis, then and now, is premised on the company’s strong prospective growth, high network effects and economic moat.
Its core commerce business is still going strong, with sales up 40% y-o-y in 2QFY2020, and accounts for 85% of total revenue. This vertically integrated business segment — that encompasses online and physical marketplaces, payments and logistics — is highly profitable, with average Ebitda (earnings before interest, taxes, depreciation and amortisation) margin of 40% in 1HFY2020.
And still has room to grow. Annual active consumers on its China retail marketplaces rose to 693 million, up 19 million from end-June, whereas mobile monthly active users (MAU) rose 30 million, to 785 million, over the quarter.
This can be attributed partly to the company’s expansion into lower-tier cities, where although spending power is comparatively lower than Tier-1 cities, it is growing rapidly as China’s middle class expands. A key part of the Chinese government’s longer-term blueprint is to expand its economic growth inland, with initiatives that include the Belt and Road.
The fastest-growing segment is cloud — revenue was up 64% y-o-y in 2QFY2020 — where its clientele includes 40% of China’s top 500 companies. The business is currently loss-making, as Alibaba is investing heavily in infrastructure and talent. But if Amazon’s cloud business, AWS — its most profitable segment with a 26.3% operating margin in 9MFY2019 — is any guide, this could be a second major income generator for Alibaba in the future.
Alibaba has also invested in a slew of assets and start-ups, including digital media, microblogging, entertainment, web browser, food delivery and ride-sharing. Many of these will probably remain in the red for the foreseeable future, but they form part of the company’s expanding ecosystem and are key in attracting and retaining customers, thus widening its moat and network effects.
That is more than we can say for some other companies that are trading at skyhigh valuations, traditionally the domain of tech stocks. Take, for instance, Beyond Meat and Impossible Foods. The former has seen its share price triple since its IPO in late April to US$74, from the IPO of US$25. Though off its record-high price of nearly US$240, the company is still valued at US$4.5 billion, or 20 times trailing 12-month (TTM) sales. It has yet to turn a profit.
Impossible Foods is reportedly aiming for a valuation of between US$3 billion and US$5 billion, versus US$2 billion valuation in May, in a new round of fundraising. The company is said to be looking at an IPO in early 2020.
We are not disputing that there is a growing market for plant-based meat. In fact, this market has been around for a long, long time. The Chinese have been serving faux meat made from bean curd for centuries. Yes, the taste is different, but it is definitely not revolutionary, no matter the hype. An interesting point to note: The jury is still out on whether Beyond Meat’s and Impossible Foods’ burgers are a more or less healthy alternative to real meat, given that they are highly processed foods.
More importantly, the two companies have zero network effect, their marginal costs will not fall drastically with scale and there is limited moat. We do not see sustainable competitive edge, despite their first-mover advantage. Every food processing company in the world will be coming up with their own products if there is proven demand. Competition will intensify and selling prices will drop. All of these competitor companies, which are actually profitable today, are trading at significantly cheaper valuations. Nestlé, the world’s largest processed and packaged food company, is currently priced at 32 times TTM net profits.
Lest we forget, the concept of coworking was not novel either. IWG, formerly Regus, is a multinational workspace and services provider founded in 1989 and listed on the London Stock Exchange, with a presence in 120 countries. But most of us would have only heard of upstart WeWork, which currently offers locations in 37 countries, thanks to all the hype surrounding its hyper growth rates and massive valuations. We all know how that story ended.
US stocks gave up some gains last week, retracing from record-high levels on renewed trade tension. The Global Portfolio fell 2.5%, paring total returns since inception to 14.5%. Nevertheless, it is still outperforming the benchmark MSCI World Net Return index, which is up 12.4% over the same period.
We disposed of our holdings in Dollar General for a 14.5% return and reinvested proceeds into Home Depot. Meanwhile, shares in Alphabet and JPMorgan Chase bucked the broader market’s decline last week, while those in The Boeing Co, Alibaba and ServiceNow fell.
Tong Kooi Ong is chairman of The Edge Media Group, which owns The Edge Singapore
