Shares of Alibaba Group Holding Limited (NYSE:BABA) slumped 9% after the company called off its Cloud Intelligence Group spinoff due to uncertainty over securing chip supplies. Alibaba’s results for the second fiscal quarter, however, were quite good, although revenue growth slowed compared to the first fiscal quarter. Alibaba generated strong earnings and free cash flow, and the company announced that it would start paying a dividend to shareholders… which should increase the appeal of Alibaba’s shares. Considering that Alibaba returned 40% of its free cash flow to shareholders in the first six months of the year and will pay a dividend, I believe Alibaba might best be seen as a capital return play going forward!
Previous rating
In my work “Cloud Spin-Off Incoming,” I said that Alibaba’s Cloud spinoff could be worth up to $60B as Alibaba pushed for a major reorganization of its business. Reasons why I rated Alibaba a hold until now related to the company’s strength in its Cainiao logistics business, but I recognized e-Commerce headwinds as well. Given that Alibaba is now a capital return play, I am upgrading BABA to buy.
Alibaba delivers a solid earnings sheet
Alibaba generated 9% top line growth in the second fiscal quarter compared to an 14% revenue growth rate in the previous quarter. Alibaba’s total revenues in FQ2’24 were 224.8B Chinese Yuan ($30.8B).
Unfortunately, Alibaba saw a slowdown in the important Taobao and Tmall Group e-Commerce business in the September quarter which generated 97.7B Chinese Yuan ($13.4B) in revenues, showing a year over year growth rate of 4%. In the previous quarter, FQ1’24, the segment saw 12% growth. However, weakness in Taobao and Tmall Group was partially offset by strength in Alibaba’s international e-Commerce operations, which saw 53% Y/Y growth in FQ2’24 (41% growth in FQ1’24) and generated 24.5B Chinese Yuan ($3.4B) in revenues.
Source: Alibaba
Despite slowing top line growth, Alibaba did, however, post strong profitability, with earnings soaring in the second fiscal quarter. Alibaba’s net income totaled 27.7B Chinese Yuan ($3.8B) compared a loss-making period last year. The return to profitability, and especially Alibaba’s strong free cash flow, underline why Alibaba’s shares are undervalued, in my opinion.
Source: Alibaba
Alibaba is now a capital return play, and announces a first-ever dividend payment
Alibaba did report a solid amount of free cash flow for the second fiscal quarter, underlining the notion that even with moderate top line growth the Chinese e-Commerce firm can generate a ton of free cash flow… which the company also uses to reward shareholders.
Alibaba reported 45.2B Chinese Yuan ($6.2B) in free cash flow in the second fiscal quarter on revenues of 224.8B Chinese Yuan ($30.8B)… which calculates to an impressive free cash flow margin of 20%. In the year-earlier period, Alibaba generated a FCF margin of 17%.
Importantly, Alibaba returns a considerable percentage of its free cash flow to shareholders through stock buybacks, which makes Alibaba a bit of capital return play (especially after the company also introduced its first-ever dividend), in addition to being a broad investment bet on the Chinese e-Commerce economy.
In the second fiscal quarter, Alibaba spent 11.8B Chinese Yuan ($1.6B) on stock buybacks, which implies a free cash flow return percentage of 26%. In the first six months of the current fiscal year, Alibaba repurchased 34.0B Chinese Yuan ($4.7B) worth of its own shares, which represents a free cash flow return percentage of 40%.
Source: Alibaba
Alibaba also announced that it was introducing a dividend in the amount of $0.125 per ordinary share which will be paid to holders of ordinary shares and ADSs as of the close of business on December 21, 2023. While the dividend payment itself, with regard to its total dollar amount, is not that significant, Alibaba signals its confidence in its business model and future earnings trajectory… which is a positive. Together with an already high FCF return percentage, I believe the deal should improve investor sentiment for Alibaba going forward.
Cloud spinoff likely only delayed
Alibaba announced that it scrapped its Cloud Intelligence Group spin-off due to concerns about U.S. chip export bans affecting China and the availability of AI chips from companies like Nvidia. The U.S. government has limited the availability of high-performance chips to China, such as Nvidia’s (NVDA) H100 chip, as they could be used for military purposes. However, in the long term, I believe Alibaba’s Cloud business will be spun off as trade tensions between China and U.S. ease.
Alibaba’s valuation vs. Chinese e-Commerce rivals
Alibaba is cheaper than cheap: shares of the Chinese e-Commerce company are trading at merely 8.2X forward earnings and 6.8X free cash flow. JD.com (JD) sells at similarly depressed earnings and FCF multiplier factors, while PDD Holdings (PDD) is more expensive on both an earnings and free cash flow basis.
Alibaba’s 8.2X P/E ratio implies a massive earnings yield of 12% which suggests that the market may be too bearish on the Chinese e-Commerce company (the FCF yield is even higher at 15%). Considering how much free cash flow the company generates, I believe Alibaba represents very strong earnings and free cash flow value for long term investors.
Risks with Alibaba
Alibaba has proven to be a volatile stock and the company has had its fair amount of disappointments, ranging from brutal COVID-19 lockdowns in China to government crackdowns and now the scrapped Cloud Intelligence Group spinoff. The biggest risk for Alibaba, as I see it, is a further slowdown in the e-Commerce business, especially in the Taobao and Tmall Group, which is still responsible for the majority of revenues in Alibaba’s business portfolio.
Final thoughts
Alibaba scrapped its Cloud Intelligence Group spinoff, which weighed heavily on shares, but this announcement clouded an otherwise solid earnings release that included a 9% top line increase Y/Y, impressive profitability and strong free cash flow (and a growing free cash flow margin). Alibaba also announced that it would start to pay a dividend… which together with an already high free cash flow return percentage makes Alibaba not only a bet on Chinese e-Commerce growth, but a capital return play as well.
Additionally, Alibaba’s shares remain firmly in the bargain zone, trading at less than 9X FY 2024 earnings… implying an earnings yield of 12%. While the scrapped Cloud spinoff is a short-term setback for investors, I believe shares should rebound quickly given the prospects for higher capital returns going forward. Alibaba, after all, is now a dividend stock!
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
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