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2019-11-11 22:01:15

Alibaba (BABA) delivered a power packed quarterly result, in spite of the ongoing turmoil and dampened consumer sentiment that persist in China with respect to the ongoing US-China trade dispute.

While other businesses have been notably impacted by depressed sentiment from the China US stalemate (such as Micron (MU) and Analog Devices (ADI)) BABA continues to post growth that would be the envy of most players. This has largely been the result of its leverage to strong secular growth trends which the business will continue to ride for a decade or more. It's for this reason that Alibaba is one of the 5 Great Businesses that I'll Never Sell, and has been a three year plus long-term core holding of the Project $1M portfolio.

Alibaba 2019 Investor Deck

Core Commerce platforms continue to grow

Once again, Alibaba's core commerce platforms continue to propel the growth of the business. Core commerce revenues were up 40% year-over-year. BABA's China marketplaces continue to expand the number of active buyers, clocking in at just under 785 MM mobile monthly active users. Both Taobao and Tmall continue to post strong user engagement. Tmall in particular saw physical goods DMV on its platform increase 26% year-over-year for the last quarter.

Such high growth rates in Alibaba's core commerce business will be sustainable for an extended period of time. Alibaba has over 50% market share in Chinese e-commerce. At these levels, there are very strong network effects which typically kick in to help cement the lead of the incumbent. Merchants and customers have made their choices as far as the shopping platforms of choice that they will continue to purchase from. The Chinese e-commerce market will continue to grow fairly robustly over the next few years. Forrester Research in fact estimates that e-commerce will increase from $1.1T in 2019 to $1.8T in 2022.

Alibaba will capture a disproportionate amount of this growth in e-commerce given that much of the future volume growth in China will come from China's tier 2-5 markets. These are the much smaller regional Chinese centers. Alibaba has a penetration rate of over 85% in Chinese urban markets but only 40% in rural areas. Being able to tap into this opportunity requires a sophisticated logistics and delivery infrastructure that can cover such a vast and geographically dispersed markets.

It's here where Alibaba investment in logistics through its Cainiao affiliate and its Suning partnership will facilitate competitive advantage, providing for next day and same day delivery across the greatest number of cities to allow such a regional opportunity to ultimately be realized. This has been seen in Alibaba's recent results with customers in Tier 3 to Tier 5 rural markets accounting for more than 50% of new user growth.

Alibaba's dominant market positioning and strong investment in supporting logistics have benefited the business in various ways. The company now has a premium base of high-quality suppliers which is helping not only overall retail revenue rise at faster rate than competitors, but also the retail revenue per user which has been growing at close to 20%.

Alibaba Cloud Business may well be the most attractive of all

Alibaba posted mouthwatering numbers in its cloud business. Cloud growth was up nearly 64% to $9.3B in revenue for the quarter. While the business was still quite some way behind the core commerce businesses as far as overall contribution to Alibaba, Alibaba Cloud has significantly more strategic value to the company.

While Alibaba's commerce business is exceptionally profitable and a significant cash contributor, Alibaba Cloud should be able to approach and surpass the operating margins of AWS over time, which posted operating margins of almost 28% in 2018, and delivered significant cash flow for the business.

Just as importantly, Alibaba Cloud also helps better diversify Alibaba into a strongly growing segment of the enterprise market. This has value to Alibaba in that even though its core commerce platform continues to strongly grow, it is nevertheless exposed to general consumer malaise and the ebbs and flows of consumer spending. Enterprise cloud will be a highly sticky service which will continue to be maintained even during economic downturns. Cloud computing is now mission critical to host and manage enterprise IT infrastructure services, and will offer an element of durability in general economic downturns. Enterprises aren't going to decide to revert back to on premise software in a pinch, whereas consumers can easily decide to defer spending. It gets Alibaba into a growing area of non-discretionary spending.

Alibaba dominates the enterprise cloud computing market, and as an early entrant into the market, it has been able to acquire almost 43% market share. BABA holds a commanding lead over all the other players in the market, with Tencent (OTCPK:TCEHY) coming in a fairly distant number two with under 12% market share.

China Cloud Computing Market Share, IDC 2019

South East Asian traction is also strong

What's also important to note about the Alibaba story is that the business represents a very interesting play on the fast growing commerce markets in the Southeast Asian region. Alibaba's Lazada provides a commerce platform across Singapore, Philippines, Malaysia, Indonesia, Thailand, and Vietnam. BABA's recent quarterly results appear to indicate that the business is continuing strong momentum in the region. Lazada achieved 100% year-over-year order growth for the fourth consecutive quarter. In particular, the business is seeing very strong traction in the apparel and accessories categories. User engagement continues to be very good amongst Lazada customers with mobile daily active users doubling year-over-year during the quarter. In fact, Lazada mobile app usage dominates in most of the markets in which it operates.

iPrice, 2018 South East Asia Commerce

Alibaba is making a concerted effort to transfer many of its core competitive strengths in its China commerce marketplaces over to its Lazada business. In particular, it's banking on strong logistics infrastructure as being a differentiator across the dispersed markets of South East Asia, where congestion bottlenecks create infrastructure headaches for delivery. Significant investment is being made by Lazada to continue to bolster its logistics network to enable faster and more efficient delivery compared to competitive offerings.

Upcoming Hong Kong listing may unlock value

Alibaba is pursuing an additional Hong Kong listing which is rumored to occur towards the end of November. It will be interesting to see if such a listing creates any sort of valuation disparity which may unlock additional value in the NYSE traded ADRs. There has been a recent trend in US listed Chinese ADRs to be taken private and then re-listed on local Chinese exchanges at a significant premium (including Qihoo 360, WuXi PharmaTech). It's entirely possible that a similar effect may be observed in Alibaba's Hong Kong listing as well, which may also benefit the US listed ADRs.

Concluding thoughts

The valuation discount in Alibaba's share price compared to fair value is rapidly closing since I wrote about the business several months back, when it was trading in the $150 range. Nonetheless, I continue to believe that the stock still trades at a significant discount to fair value and that investors buying here will be very happy with long-term results. The secular growth trends which are propelling momentum in Alibaba's business today will continue to positively shape results for a significant time to come.

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Disclosure: I am/we are long BABA. 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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