Alibaba: Geographic diversification can reduce downside risks (NYSE:BABA)

Ali Baba (New York Stock Exchange: Alibaba) (OTCPK:BABAF) The stock has failed to show strong upward momentum over the past few quarters. Despite the extremely low valuation, the stock failed to impress Wall Street. Show recent quarterly earnings A potential silver lining could shift sentiment toward the stock. In the latest quarter, Alibaba reported 45% year-over-year revenue growth in its international digital commerce group. Revenue rose from CNY 18.9 billion in the same quarter last year to CNY 27.5 billion in the latest quarter. On the other hand, consolidated revenue growth was only 7%. In the Previous article,Potential improvement in cloud business was mentioned. Alibaba reported EBITDA growth of 45% year-on-year in the cloud segment, bringing annual EBITDA to $800 million.

Over the past two years, international trade revenue has almost doubled, from 14 yuan 1 billion yuan in the quarter ending March 2022 to 27.5 billion yuan in the last quarter. This has increased the revenue share of this segment from 6.5% to 13%. At the current growth rate, international trade should contribute approximately 25% of total revenues by the end of 2025. Rapid growth in international business is a good hedge against current geopolitical tensions. It also gives the company a good growth path to expand into different geographies.

The loss in the international trade sector doubled from CNY 2.1 billion in the same quarter last year to CNY 4 billion in the last quarter. However, this increase in loss is mostly due to the higher rate of investment in its international operations. A higher international revenue base helps increase the footprint of Alibaba’s profitable cloud business. With the company’s vast cash reserves at its disposal, it has a significant advantage in many international territories where it competes with smaller competitors. Alibaba shares are very cheap when we look at the fundamentals and strong growth potential in the international business, which reduces domestic risks and increases diversification.

International trade can change sentiment

Figure: Comparison of Alibaba’s PE ratio with other Chinese stocks. source: YCharts

We can see from the above chart that Alibaba along with other major Chinese stocks has a very low PE ratio. In comparison, US tech companies like Apple (AAPL), Alphabet (GOOG), and Meta (META) have forward P/E ratios ranging from 25 to 30. At its peak, Alibaba’s P/E ratio was close to 30 during the second half of 2020. Rapid international expansion could boost Alibaba’s forward P/E multiple above 20. High profitability in cloud services, on-premises services and other sectors should also help improve the EPS trajectory, giving the stock strong upside potential.

The current bearish sentiment towards Alibaba and other Chinese stocks is largely due to geopolitical tensions. However, Alibaba’s international trade business has the potential to change sentiment toward the stock. Over the past two years, the revenue base of this segment has doubled, increasing the revenue share of this business to 13%. Nearly 65% ​​of total year-over-year revenue growth in the latest quarter came from Alibaba’s international commerce business. This shows the importance of this sector for the company.

Figure: Rapid growth in international trade business. Source: Alibaba files

Figure: Alibaba’s International Trade Group two years ago. Source: Alibaba files

We can see from the image above that Alibaba has achieved rapid growth in its international business over the past two years.

Alibaba owns a significant stake in several global e-commerce companies. One of the most successful of these companies is Turkey’s leading e-commerce company Trendyol, in which Alibaba owns more than 85% of the shares. Trendyol had a valuation of $16.5 billion in 2021. In 2023, Alibaba announced another $2 billion investment in this company to expand its business in the region. Alibaba has also pumped more than $600 million into Lazada as it competes with rivals in Southeast Asia.

These investments come at the cost of higher losses. Alibaba’s losses in international business doubled last year and increased to $566 million in the latest quarter. The international sector is now the company’s biggest loss-maker.

Figure: Alibaba’s EBITDA in international trade and other sectors. Source: Alibaba files

However, Alibaba has large cash reserves and can easily burn more money than most international competitors. We recently saw management announce another major buyback program worth $25 billion. This shows that Alibaba can easily absorb the current annual loss rate of $2 billion in the international sector.

The path to 25% revenue share

It is very important for Alibaba to diversify its revenue base. This allows the company to hedge against some geopolitical risks and also helps build a longer growth runway. China’s e-commerce business is quite mature, and it will be difficult for Alibaba’s scale to achieve double-digit growth in China. On the other hand, many of the international regions into which Alibaba is expanding are relatively underpenetrated in terms of e-commerce. They also have less competition, which helps Alibaba gain a higher market share.

Alibaba has managed to achieve year-on-year revenue growth of 40% to 50% in the international trade segment over the past few quarters. If Alibaba can continue its current growth momentum in international commerce, the sector should gain a 25% revenue share by the end of 2025. This could lead to a massive shift in how Wall Street views Alibaba. It should be noted that the International Trade segment shows revenues from e-commerce operations only. Alibaba has a thriving cloud business in many international locations. Hence, total revenue from international operations is greater than the company’s core international trade group.

Stay away from geopolitical tensions

Recently, Jennifer Investor published a thesis stating that Alibaba is simply uninvestable due to geopolitical tensions. To be sure, the risks in Alibaba and other Chinese stocks have increased due to the recent tensions. However, investors need to look closely at the risk-return dynamics in the current situation. Bloomberg recently published an article stating that any invasion of Taiwan would likely have a greater impact on the global economy than the Great Recession of 2007-2008. If there is an escalation, investors will need to reevaluate their entire portfolio and not Alibaba or any single stock they own.

For example, Apple gets 16% of its total revenue from China and any escalation will certainly hurt its sales in the region as well as the entire supply chain. There are a large number of companies that rely on the supply chain from Taiwan and China. Any major disruption is likely to lead to significant declines in many sectors.

As mentioned above, the recent growth of international trade should be a good hedge, as Alibaba is seen as a global trading company rather than a China-centric company.

Risks that threaten the thesis

Alibaba is rapidly expanding into international regions. However, it is possible to face opposition from regulators in many regions. We have already seen new EU rules regarding data protection and anti-dumping rules, mostly targeting Chinese companies. India also took a tough stance against Chinese companies after a border dispute between the two neighbors. This has led to Alibaba selling its stakes in a number of startups in India and reducing its presence.

While Southeast Asian countries, Turkey, Latin America and many other regions are more keen to attract investments from Alibaba and other Chinese companies, this trend could certainly change according to geopolitical relations. We have already seen how geopolitical tensions can lead to a rapid deterioration in business opportunities.

If Alibaba fails to maintain the current growth trajectory in international trade, it will significantly change the expected revenue share of this sector. Alibaba is on track to reach 25% revenue share for its international commerce business by the end of 2025. However, investors will need to closely monitor Alibaba’s geopolitical trends and growth trends in different sectors in the next few quarters.

Impact on Alibaba shares

Alibaba’s management has taken several steps to improve the growth momentum of the international business. It has a huge cash pile and free cash flow that can be used to support international investments. Alibaba also invests heavily in rewarding investors through cash buybacks and dividends. The company repurchased $4.8 billion worth of stock in the first quarter. This equates to about 2.5% of shares outstanding in one quarter, or 10% on an annual basis. Additionally, the company has a healthy dividend yield. The current buyback program and free cash flow could sustain these buybacks for a number of quarters. We should see a rapid trajectory for EPS growth over the next few quarters, which should act as a tailwind to the stock’s sentiment.

Figure: Alibaba’s forward PE and price to FCF ratio. source: YCharts

Alibaba’s forward PE and price-to-free cash flow ratio are below 10. The company has strong fundamentals and is showing rapid geographic diversification. If the current trend of higher year-on-year international growth continues over the next few quarters, Wall Street may get a much better view of the company and its future growth potential.

Investors looking for stocks with modest prices and a good moat can take a look at Alibaba. While there are certainly geopolitical risks associated with Alibaba, the company has strong fundamentals and is showing rapid geographic diversification, making its current valuation look attractive.

Investor takeaways

Alibaba is rapidly expanding into international regions. It has doubled its international revenue in the last two years and the segment’s revenue share now stands at 13%. With the current growth trend, the international trade segment could have a revenue share of 25% by the end of 2025. This would provide the company with a good hedge against geopolitical tensions and also a better growth path.

Huge investments in international regions have led to greater losses in this sector. However, Alibaba has significant cash reserves and can maintain this burn rate in order to gain higher market share in key international regions. The stock is very cheap due to regulatory and geopolitical headwinds. But we could see a more diversified company over the next few quarters, which could help improve sentiment around the stock and drive a nice upside.