Despite Alibaba’s strong run, it’s still undervalued

Chelsey Tam | Morningstar

Alibaba will increase capital expenditure beyond the committed CNY 380 billion as AI infrastructure demand is exceeding expectations. It anticipates its global data center energy use to be 10 times above the 2022 level by 2032 and will partner with Nvidia to build physical AI capabilities.

Why it matters

We think higher capex is essential to meet the stronger-than-expected demand for artificial intelligence infrastructure domestically and internationally. The projected surge in global data center energy consumption signals a robust outlook for cloud revenue.

• The physical AI collaboration will drive AI adoption across industries such as auto and robotics. Alibaba’s increased investment in overseas data centers, competitive performance, widespread use of its open-source models, and improved performance of its self-developed chip all support cloud revenue growth.
• We now assume capex will average 15% of revenue over the next three years, resulting in an 11% average lift in cloud revenue over the coming decade versus previous forecasts. A higher contribution from high-margin AI revenue led to a 12% average increase in our adjusted EBITA estimates.

The bottom line

We raise wide-moat Alibaba’s fair value estimate by 49% to USD 267/HKD 260, reflecting stronger cloud profits, higher stage two assumptions due to AI demand, and a reduced holding discount on noncurrent investments to 10% from 30%. The shares appear undervalued.

• As of the June quarter, Alibaba’s cash and investments accounted for 49% of its current market capitalization. The firm divested stakes in noncore businesses, increased dividend payouts, and repurchased shares in fiscal 2024-25, leading to the reduced holding discount.
• Alibaba’s aggressive AI investment strategy, strong capabilities and market share in AI cloud, leadership in open-source models, and full-stack AI infrastructure position it well to capture robust AI demand growth in China and, to a lesser extent, internationally.

Source: Morningstar

Business strategy and outlook

Alibaba is losing market share to PDD and Douyin in the China e-commerce business, and we don’t see a quick fix in the near term. Alibaba’s number of annual active consumers in the China retail marketplace was surpassed by PDD in the fiscal year ended March 2021. Meanwhile, Douyin has gained share from Alibaba, especially in the beauty and apparel categories in recent years, and entered the traditional search-based e-commerce space, competing directly with Alibaba. The number of annual active consumers at Alibaba is close to the ceiling in China. Alibaba’s gross merchandise volume to China’s online retail sales of goods ratio was 62% in the year ended March 2023 at Alibaba, down from 72% in the year-ago period. We believe Alibaba’s marketplace monetization rates will decline in the long run, due to a mix shift toward Taobao, which has a lower take rate compared with Tmall, and more competition.

In our view, the Taobao and Tmall marketplaces remain as Alibaba’s core cash flow driver and can support the expansion of AliCloud as well as the firm’s globalization strategy, which offers long-term growth potential. While AliCloud will remain in investment mode in the medium term, downsizing low-margin businesses can drive segment margins higher over time. On globalization, the Alibaba international digital commerce group’s year-on-year revenue growth has been strong recently, thanks to AliExpress’ expanding cross-border business.

We expect Alibaba to return more capital to shareholders and increase its return on invested capital after divestments of noncore investments. We are pleased that Alibaba has upsized its share-repurchase program by USD 25 billion until March-end 2027 to USD 35.3 billion. Management targets to lift ROIC (based on Alibaba’s calculation) from single digits in fiscal 2023 to double digits in the next few years. Alibaba had sizable cash and equivalents and investments of CNY 829 billion on its balance sheet as of December 2023.

Bulls say

• Alibaba is able to maintain or increase its gross merchandise volume share in China’s e-commerce space, demonstrating its ability to execute its turnaround strategy.
• Alibaba successfully increases key metrics such as customer retention, purchase frequency, and average order value, driving GMV growth to outperform the growth of China’s online retail sales of physical goods.
• Alibaba delivers better-than-expected adjusted EBITA margins despite competition and reinvestment.

Bears say

• Alibaba’s GMV share in China decreases faster than we expect as competitors such as Douyin successfully enter the search-based e-commerce business.
• Expansion into the nonphysical goods marketplace businesses and other regions leads to lower-than-expected margins, and the timing of profitability is delayed.
• Alibaba fails in its globalization, public cloud, and AI efforts and delivers slower-than-expected earnings growth

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