EUR 850.00 For Business Accounts Only

Morningstar | Alibaba's Core Commerce Growth Show Resiliency to Trade War Headlines; Long-Term Growth Story Intact

Despite concerns about trade wars, the key takeaway from Alibaba’s first-quarter update was the resiliency of its business model--partly a byproduct of the network effect underpinning our wide moat rating--and the various levers for top-line growth. Revenue increased 61%--including contribution from core commerce (61%), cloud computing (93%), digital media (46%), and innovation/other (64%)--putting Alibaba on track to meet its full-year revenue growth target of 60%. While earlier stage businesses show considerable long-term promise, we view the core commerce performance as the most important for three reasons. One, active buyers (up 24%) are accelerating--especially in lower-tier cities--implying organic growth potential. Two, user engagement is increasing through local services offerings, with new monetization opportunities available through the 88VIP loyalty program. Three, growth trends support our belief that trade wars will have a minimal impact on consumption patterns. As such, we're raising our five-year average annual revenue growth outlook to 38% from 35%.

The other notable topic was margins. This quarter was anticipated to have several moving parts due to the consolidation of Cainiao and Ele.me as well as "New Retail”/other experience investments, though gross margin (which fell to 46% from 65%) and adjusted EBITDA margin (36% from 50%) compression was more pronounced than we anticipated. Still, after adjusting for these factors and non-cash stock-based compensation expenses tied to Ant Financial, core commerce EBITDA margins encouragingly remained flat at 62%. While ancillary business investments will likely weigh on margins the next few years, we see consolidated EBITDA margins in the low-30s as a reasonable long-term assumption.

Our updated revenue and profitability assumptions will effectively cancel each other out, leaving our $240 fair value estimate unchanged. While we appreciate the market's macro concerns, we see shares as undervalued.

Unpacking Alibaba's first-quarter update in greater detail, we believe it's important to look at the potential impact of trade wars on Alibaba's operations. Generally speaking, we share management's views that the impact of trade wars will be muted. Leveraging Morningstar's previous 10-year economic outlook for China--including our March 2017 report, "The Next 10 Years: Demographics Trend Reversals will Reduce Growth and Reshape the Economy"--our longer-term estimates have long assumed a slowdown in China GDP growth rates to the 4% range but still being driven heavily (90%-plus) by household consumption rates as opposed to government consumption or export activity. Coupled with relatively healthy Chinese household balance sheets and easier access to capital, we don't see any major impediments to consumer spending in the region other than trade war headline risk, adding conviction to our updated longer-term revenue growth assumptions.

We're intrigued by the launch of the "88VIP" subscription-based loyalty program this month, which offers Alibaba marketplace members discount savings on Tmall, consumer electronic product coupons, access to video-streaming platform Youku and music-streaming platform Xiami, online movie tickets, and delivery services through Ele.me. As we've pointed out in our previous work on Amazon and the broader e-commerce industry in general, the path to longer-term profitability doesn't just come from product sales themselves--though Alibaba's third-party approach to marketplaces certainly offers strong margins--but also new subscription services (where the upfront content investments have been made and contribution from each incremental subscriber falls almost directly to the bottom line), subscription pricing tiers, and other bundled services. While it will take time before contributing to results, we believe this loyalty program will be an important to our longer-term GMV, revenue growth, and margin assumptions.