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2019-05-24 02:03:41

In the recent quarterly earnings, Alibaba (BABA) was able to beat its main rivals, JD.com (JD) and Tencent (OTCPK:TCEHY) in terms of revenue growth. After excluding the effects of acquired businesses, Alibaba reported YoY revenue growth of 39%. This was ahead of JD.com's 21% growth and Tencent's 16%. Both JD.com and Tencent reported their lowest revenue growth in the last few years. This has increased the gap between Alibaba's revenue growth and that of its two main rivals.

We should see a continuation of this trend as Alibaba improves its foothold in new services and international regions. It must be noted that Alibaba's international business through investments and acquisitions is miles ahead of Tencent and JD. However, Alibaba would need to be careful about the rapid growth in Pinduoduo (PDD), a social commerce company which has rapidly increased its GMV and customer base. At close to $150, Alibaba stock is looking attractive with much lower valuation multiples. Investors need to look at these positive trends to gauge the long-term growth potential of Alibaba.

Leaving rivals behind

Fig: Increasing revenue growth gap between Alibaba and rivals in the last few quarters.

In yuan terms, Alibaba reported 51% YoY growth, whereas JD reported 21%, and Tencent had 16% growth. The asset-light model of Alibaba has allowed the company to penetrate lower-tiered cities in China at a rapid pace. It does not need to invest heavily in logistics at the same rate as JD. Heavier investment by Alibaba in other segments has increased the revenue growth gap with its main e-commerce rival.

Tencent is struggling with its own issues. It has reported slower growth in the gaming segment due to regulatory hurdles in China. Recently, some of the gaming regulations have been eased, but it is unlikely that Tencent will be able to deliver a revenue growth similar to the past few years. Tencent is the main rival of Alibaba in a wide range of services. Tencent has over 20% stake in JD, and it has also invested heavily in Pinduoduo.

Slower growth in Tencent would force the company to divert more resources to its core business. This should reduce the competitive environment for Alibaba in a number of segments.

Increasing profitability

Faster growth in revenue by Alibaba has not been at the expense of profitability. The free cash flow growth of Alibaba has been phenomenal in the past few quarters. The increase in free cash flow divergence should help Alibaba in increasing the pace of investments in future growth segments.

Fig: Alibaba's revenue in the year-ago quarter and the latest quarter in total core commerce and cloud computing. Source: Alibaba filings

Alibaba has been investing heavily in cloud computing. The company wants to build this segment to a level similar to Amazon (AMZN). In the recent quarter, the cloud computing growth was 76%, which was higher than its total core commerce segment. Alibaba's main rival in this segment is Tencent. Tencent has combined its fintech and cloud business in a single segment. Tencent's YoY growth in this segment was 44%. We can see that this growth rate is substantially lower than Alibaba's.

The cloud computing segment of Alibaba has low margins and is currently in an expansion mode. With economies of scale in this business, Alibaba should be able to improve its margins and net income in the cloud computing segment. The top management of Alibaba has already mentioned that cloud computing would be the main business of the company in the future.

Threat of Pinduoduo

Most of the analysts believed that the e-commerce field in China was a two-horse race between Alibaba and JD. However, Pinduoduo has used innovative initiatives to expand its e-commerce business. PDD uses group buying options to attract new customers and give better prices to customers. In the recent quarter statement, PDD announced 181% growth in trailing twelve-month GMV, which has increased to 557 billion yuan ($83 billion). The average monthly user base increased to 289 million compared to 166 million in the year-ago quarter.

If PDD can maintain these growth numbers, it would soon be a big challenge for Alibaba. At the same time, Alibaba mentioned that they are also making changes in their apps to attract a more diverse customer base, especially from smaller towns and cities in China. Investors should keep a close look at the future growth trajectory of PDD.

Alibaba's valuation

The last few weeks have seen a rapid decline in Alibaba's stock price due to trade concerns. The stock is down by over 20% since the trade negotiation broke off. The long-term fundamentals of the company are still very strong. If it continues to take market share away from rivals, we should see better margins and EPS from Alibaba. This will end up helping the bullish sentiment for the stock.

Alibaba is trading at a forward PE multiple of only 23, while the forward revenue guidance is of 33%. Growth in cloud margins should also improve the overall EPS. The EPS estimates for 2 fiscal years ahead is at $11.5. The stock is trading at only 14 times this metric.

Although there can be some more bearish sentiment due to ongoing trade tariffs, the long-term fundamentals of the company are very solid.

Investor takeaway

Alibaba has reported better revenue growth compared to rivals for the past four quarters. In the latest quarter, the revenue growth difference between Alibaba and its main rivals, JD and Tencent, is quite big. This should increase the market share of the company in core commerce. It will also give Alibaba an opportunity to diversify into new segments.

Alibaba faces new challenge due to the growth of PDD. But Alibaba's GMV is still 10 times that of PDD. The recent dip in Alibaba's stock price has made the stock quite cheap. Investors looking for a long-term buy and hold option should consider Alibaba as a possible bet.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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