Value investors are at a loss to explain the performance of Alibaba (NYSE:BABA) stock. Holding BABA stock in the hopes that the shares can return to their 52-week high may prove to be unprofitable.
That’s because China’s government is introducing stricter regulations in many sectors. So despite paying a $2.75 billion fine for anti-monopoly violations, the e-commerce giant still faces risks.
What do the new regulations mean for Alibaba’s outlook?
The Regulatory Crackdown Is Hurting BABA Stock
Last week, China’s State Council and the Chinese Communist Party’s Central Committee outlined a 2021-2025 plan. Under the initiative, China’s regulations that affect many industries, especially the tech sector, will be tightened.
Chinese officials are looking to intensify the government’s influence over tech companies. Before the new plan’s release, China had already signaled its displeasure towards DiDi Global’s (NYSE:DIDI) initial public offering.
Days after the IPO, China removed 25 DiDi apps from the nation’s online stores, citing DiDi’s allegedly illegal collection and use of consumer data. That decision sent BABA stock lower earlier this month. Around the same time, on Aug. 3, Alibaba posted its results for its fiscal quarter that ended in June.
The political unknowns circling Alibaba overshadowed the company’s healthy quarterly results.
In the June quarter, Alibaba’s annual active customers reached 1.18 billion. 912 million of whom were located in China. Alibaba’s Chairman and Chief Executive Officer, Daniel Zhang, said, “we will continue to strengthen our technology advantage in improving the consumer experience and helping our enterprise customers to accomplish successful digital transformations.”
The company will reinvest its profits and excess capital to support its merchant network and improve the experience of its customers. As far as Alibaba Cloud, the loss of a single top cloud customer hurt the unit’s revenue. Excluding that development, its cloud revenue would have grown 40% year-over-year.
Alibaba, however, does not have many options available to fill the void left by the large client. Moreover, the government’s crackdown on the online education space lowered Alibaba Cloud’s revenue.
But over the long-term, Chinese companies that need cloud infrastructure will choose Alibaba’s solution. And the demand for computing, data storage, cybersecurity, and data analytics is rising in China. As a result, strong demand for Alibaba Cloud will offset any growth deceleration of the conglomerate’s e-commerce unit.
Cloud computing accounted for RMB 12.4 billion of Alibaba’s revenue last quarter. Its e-commerce business generated RMB 133.3 billion of sales in the quarter.
Alibaba’s core e-commerce offerings have room to grow. Alibaba will keep developing a comprehensive digital ecosystem to attract more merchants and even more customers.
Alibaba has yet to unlock the value of its Ant Financial unit, as the subsidiary’s IPO was canceled by Beijing. Eventually, after the government bestows its blessing on the deal, the discount in BABA stock will dissipate.
Until then, the company has a $10 billion to $15 billion stock buyback plan. That is the largest such plan in the company’s history, and it will increase shareholders’ returns. From April 1 to June 30, Alibaba spent $3.7 billion to buy back 18 million of its shares.
Research firm Bernstein wrote on Aug. 13 that it’s still “lukewarm on the outlook for Alibaba’s shares.” The firm added that, “stabilisation in core e-commerce profitability remains the key to better share price performance.”
In an unusual development, Alibaba’s top line for last quarter came in below analysts’ average outlook . Before its latest earnings report, the company had not missed Wall Street’s mean quarterly revenue estimate for over two years. The crackdown on Chinese tech firms may have distracted Alibaba and slowed the spending of its customers, with the cloud business taking a particularly big hit.
Wall Street analysts, however, all reiterated their “buy” rating on the stock in the wake of the June quarter results. Their average price target on BABA stock is $275, according to Tipranks.
And the shares trade at low valuations compared to Amazon.com’s (NASDAQ:AMZN) stock. Amazon.com’s e-commerce revenue rose just 16% YOY in Q2 as consumers spent less time and money online. Alibaba’s retail e-commerce revenue, conversely, grew 34% YOY last quarter.
The Bottom Line
Alibaba is shrewdly taking advantage of its weak stock price by buying back its shares The e-commerce giant is a true value play, but it’s facing very real risks from the Chinese government.
Markets do not know when China will stop imposing more regulations on tech firms. Until that trend ends and the country signals that it will let Alibaba thrive again, the stock will underperform.
At that point, the selling pressure on Alibaba’s shares will end. And when bears stop selling, the stock will bottom. Investors should accumulate the stock when that happens.
On the date of publication, Chris Lau did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.