Why Alibaba Stock Deserves to Trade Above $200
In late 2018, all hope seemed lost for Alibaba (NYSE:BABA) stock. The Chinese e-commerce giant was fighting a plethora of headwinds.
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Its growth was slowing, and its margins were falling. The global economy was cooling. China’s economy was even weaker, thanks to escalating trade and foreign-exchange headwinds. As a result of these trends, BABA stock dropped from its $200-plus highs in mid 2018 to $130 in late 2018.
That was a dip worth buying. Things have improved for BABA and BABA stock in 2019. BABA’s revenue growth rates have remained healthy, while the declines of its margins have moderated. The global economy has stabilized. China’s economy has bounced back. The trade and foreign-exchange headwinds it was facing have become less severe. Consequently, BABA stock has rallied from $130 in late 2018 to $188 today.
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The rally of BABA stock will continue. Indeed, I think BABA stock may once again exceed $200 relatively soon.
The logic is simple. Alibaba stock was really beaten up in late 2018 on short-lived headwinds and weaknesses that are now fading. As they continue to fade in 2019, BABA should be able to reclaim its previous highs, and then some, given that BABA’s fundamentals are improving, while its valuation is reasonable.
All in all, BABA stock looked great in late 2018, but even after its big early 2019 rally, it still looks pretty good at this point. Consequently, BABA can reach $200 in the near future.
The Fundamentals Look Great
The long-term bull thesis on BABA stock is supported by three big growth drivers.
Alibaba is the king of the world’s largest e-commerce market. China is the world’s largest e-commerce market by a mile, and it’s growing at a 30%-plus pace in a retail market that is expanding at a high-single-digit-percentage rate.
Meanwhile, China’s GDP is expanding at an annual rate of at least 6%. In other words, China’s e-commerce market is one of the healthiest, strongest growth markets in the world. BABA is the undisputed king of that market, whose core domestic revenues are expanding at a 35% clip. For the foreseeable future, BABA’s China revenues should continue to increase at least 20% annually.
Alibaba is positioned to become the king of one of the world’s fastest growing e-commerce markets. Southeast Asia is the world’s fourth largest economic region by GDP. It also has an anemic, low-single-digit-percentage-online-shopping penetration rate, versus a global online-shopping penetration rate of 15%.
This combination of huge GDP growth and low e-commerce penetration suggests that the region’s e-commerce sector can expand tremendously over the next several years. BABA is capitalizing on this growth potential by expanding into a number of Southeast Asian countries. Consequently, the company’s international businesses should grow at least 20% for the foreseeable future.
Alibaba has a small but rapidly growing cloud business that has tremendous long-term potential. Alibaba’s cloud business is relatively small (it generated only 6% of the company’s total revenues in Q4). But it’s growing very quickly (it expanded more than 80% in Q4) in a market that is expanding at a compound annual growth rate of around 15%,. Moreover, it can continue to grow quickly because only 20% of enterprise workloads have migrated to the cloud. As a result, Alibaba’s cloud business should grow at least 30% for the foreseeable future.
Overall, this company’s long term growth fundamentals look great. The only concern, then, is its near term fundamentals. But those are improving, too. China’s economy is picking back up. A trade deal appears likely to be in the cards in the near future. Recession fears have receded. BABA’s margins are showing signs of bottoming.
All together, the fundamental outlook of BABA stock is about as good as ever.
The Valuation of BABA Stock Supports Further Upside
BABA’s long-term growth fundamentals imply that BABA stock should trade well north of $200 in the near future.
Over the past several years, BABA’s revenue growth has been at least 50%. Its growth is cooling now, and it will inevitably continue to cool over the next several years as China’s economy matures, global e-commerce penetration rates rise, and the growth of the cloud slows.
But, assuming that BABA still gets 20%-plus growth from China commerce, 20%-plus growth from international commerce, and 30%-plus growth from the cloud over the next several years, then Alibaba’s top line should reach roughly $200 billion by fiscal 2025.
During that stretch, I think that the growth of BABA’s cloud business will help stabilize its margins, and that its adjusted profit margins could reach about 25% by the end of 2025. That combination of $200 billion of revenue and 25% profit margins should produce earnings per share of about $18.
Applying a forward multiple of 20, which is average for growth stocks, along with EPS of $18, I arrive at a fiscal 2024 price target for BABA stock of $360. Discounted back by 10% per year, that equates to a fiscal 2019 price target north of $220.
The Bottom Line on BABA Stock
Alibaba is a big growth company with healthy long term growth fundamentals. Investors simply forgot about those healthy long-term fundamentals in late 2018 as the company’s near term headwinds mounted.
Now those near term headwinds are fading, and as they continue to fade in 2019, the market’s focus will shift back to the healthy fundamentals of Alibaba stock. Ultimately, that shift will keep BABA stock on a healthy uptrend.
As of this writing, Luke Lango was long BABA.
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