Analysis of BABA

Alibaba Group is one of the leading platforms for wholesale trade in the world that hosts the largest B2B (Alibaba.com) and B2C (Taobao, Tmall) marketplaces globally. In fact, its online sales and profits have surpassed those of all the US retailers, including Walmart, Amazon, and eBay combined, since 2015 (Alibaba Group, 2018). Alibaba Group has developed businesses in cloud computing, business-to-business marketplaces, consumer e-commerce, Internet TV, mobile operating systems, and mobile applications spheres (Alibaba Group, 2018). It has used its strengths to provide a new way of doing commercial activities that entails improving the visibility of the products manufactured worldwide. It has changed the world into a global hub where every buyer and seller can have commercial intercourse.

The mission of Alibaba Group is to facilitate businesses’ operations anywhere in the world. The company has expanded by providing essential tools to suppliers to showcase their products globally and by helping the buyers locate them as well as the suppliers in the most efficient and effective way. Today, Alibaba offers millions of products in over 40 categories, which include fast-moving consumer goods (FMCG) such as chocolates, fast-moving consumer durables (FMCD) such as electronic items, capital goods, apparels, and many others. Furthermore, Alibaba has continued to develop services such as an e-commerce platform to help businesses explore more opportunities and conduct more operations (Alibaba Group, 2018). By developing the infrastructure of commerce, the firm is expected to continue expanding to new markets.

5 Year Stock Price

The plot above has objectively rated the company’s stock according to its risk-adjusted total return prospect over a 12-month investment period. In comparison to the NYSE composite index, Alibaba is more volatile as indicated by the rapid price fluctuations witnessed in the last five years. NYSE Composite Index is more consistent despite the slow growth of returns in comparison to Alibaba. Essentially, Alibaba stock brings a higher return as it is indicated in the plot above. NYSE Composite Index has seen a slow and steady rate of return unlike Alibaba stock and thus it is evident that Alibaba has performed better than other businesses in the industry.

Recent Events That Have Affected the Stock Price for Alibaba Group

The stock price for Alibaba Group is boosted by a significant number of changes that have affected it positively despite the weaknesses that hindered its performance. As a result, the strengths have boosted investor confidence, enhancing the positive outlook for Alibaba unlike it happened in a large number of stocks, as indicated by the NYSE Composite Index. Alibaba Group is seen to have a strong revenue growth enhanced by the fact that it does approximately 80% of online market transactions in China. The increase in profit margins, good cash position, and impressive return on equity are strengths that have consistently attributed to Alibaba’s net income growth and notable stock price returns in the last five years. BABA’s growth of revenue is notable since it has surpassed the average revenue growth of the industry that currently stands at 24.8%.

The growth of the company’s revenue remained considerable despite the decrease in the earnings per share. The reasons for the earnings decline is the increase in share-based compensation, which included US$241m of mark-to-marker non-cash items for share-based awards. The decline in earnings is explained by the USS134m one-off charges for early repayment of USS8bn bank borrowings. Moreover, the declining earnings were caused by an increase in income tax following the expiry of an income tax exemption at one of the group’s major subsidiaries. Net profit margin was 32%, which is a decrease from 57% in 2013. Nine-month net profit ending on December 31, 2014 totaled Rmb21.2bn (US$3.4bn).

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The return on equity has been improving on a year-to-year basis and it can be interpreted as a moderate strength of Alibaba Group. Comparatively, Alibaba Group’s return on equity has shown better performance results in comparison to the S&P 500 and the industry average. The rise of the net operating cash flow by 75.71% depicts that the company is in a good cash flow position. In the past five years, Alibaba Group’s stock price has increased despite the S&P 500 appreciation. However, the stock has an upside potential risk in spite of the continuous growth witnessed in the past year. Alibaba Group’s EPS has reduced despite the positive income growth. However, this year, the company’s EPS is forecasted to increase based on the strong sales growth experienced in the current year.

The Weighted Average Cost of Capital for ADR on December 6, 2018

The WACC calculation includes the costs of both Alibaba’s debt and equity, each of which is weighted based on its relative use by the company.

Weights

a) Weight of equity = E / (E + D) = 395228.46 / (395228.46 + 16590.11) = 0.95

b) Weight of debt = D / (E + D) = 16590.11 / (395228.46} + 16590.11) = 0.04

Cost of Equity

a) The risk-free rate is 2.98%.

b) Beta is 1.77.

c) Market premium is 6%. Thus:

Cost of Equity = 2.98% + 1.77 * 6% = 13.6%.

Cost of Debt

Alibaba Group’s total Book Value of Debt (D) is $16590.11Mil and the interest expense is $564.47 Mil. Thus:

Cost of Debt = 564.47 / 16590.11= 3.40%.

Tax Rate

The tax rate utilized is 20.54%.

WACC

Alibaba Group’s WACC is:

WACC=E / (E + D)*Cost of Equity+ D / (E + D)*Cost of Debt*(1 – Tax Rate)

=0.9597*13.6%+0.0403*3.4025 %*( 1 – 20.54%)

=13.16%.

Based on the above computation, the WACC for the firm is 13.16%. It indicates that the cost of debt accessing is high. Therefore, a lot of care needs to be taken when using the debt in financing projects.

CEO Letter and Performance Summary of 2018

The CEO reported that the Core Commerce segment of the company contributed approximately 60% to its revenue in 2018 financial year. This revenue growth is seen to be the largest since its IPO in 2014. The strong revenue growth is attributed to different effective commitments shown by various segments simultaneously. As such, the investment in China’s retail marketplaces, the diversity of the company’s operations, the increase in retail global markets, and innovation in retail industry have contributed to its notable year-to-year sales growth. Furthermore, the CEO mentioned Taobao’s success in the retail segment in 2018. This success happened due to the company’s innovativeness in the spheres of intelligent personal recommendations and content formats that redefined the customers’ shopping experience. This strategy created more traffic among user engagements, active consumers, and purchase conversions.

The CEO highlighted the continual expansion in B2C market leadership and wallet share as physical goods increased by 45% in 2018. This growth indicates a strong market leadership and accelerated growth in different segments including consumers, home appliances, apparels, and many others. The CEO additionally reported a growth in the global and cross-border retail businesses as indicated by the increase by 94% in the international commerce retail business in 2018 (Alibaba Group, 2018). Cainiao Network is reported to have its logistics data enabled to make consumer deliveries faster and more accurate. From this perspective, the launch of the first-ecommerce dedicated intercontinental flight has significantly reduced the delivery period. Cloud computing growth has shown the considerable growth rates as it increased by 101%, which is attributed to the higher numbers of value-added products, revenue-per-customer, and paying customers. Alibaba Group consented to 33% value at stake in Ant Financial to reinforce the vital relationship by conforming to the 2014 Ant Financial agreements. This stake extended the association with Ant Financial, which will be beneficial to the company as it will propel the New Retail system with mobile payments. The operating activities brought US$2,261 million in net cash, which translated to the 32% growth in a similar quarter of 2017. Furthermore, the CEO highlighted the increase in liquidity as indicated by 7% growth of free cash flow to achieve US$1,365 million in 2018.

Common Financial Rations

Alibaba Group reported an operating and net margins boosting evident through the year-to-year growth in its revenues in the past three years. The strong growth in the generation of revenue is explained by the company’s ability to establish positive equity rates to generate more revenue. Between 2016 and 2018, Alibaba Group had a decline in its cash position as there was an increase in the liquidity ratios. For instance, in 2018, the current and quick ratio decreased while the cash ratio increased. This is attributed to the increased investments, capital expenditure, and global expansion. Essentially, Alibaba’s position is an indication of good business environment achieved by positive financial results. However, DSO declined after the improvement witnessed between 2015 and 2016. DSO and DIO were smaller than the DPO, which resulted in the payments being delayed. When examining the balance sheet and the income statement, it is essential to use the important financial figures to depict the current financial status of the company. Notably, about 65% of its revenue is attributed to the Chinese market, which highlights the key position this market plays for Alibaba’s performance (Baba, 2018). 83% of revenue is attributed to the core commerce segment and the remaining amount comes from other revenue segments where the company operates. The income obtained from operations constitutes 15% of the revenue, indicating the decrease by 3% when compared to the 2017 annual report. Comparatively, there is an increase seen in the revenue growth in Alibaba’s revenue segments, indicating the improvement of its performance and thus showing that the company is in a state of financial health.

Adjusted EBITDA achieved the growth of 17% as compared to 43% in 2017 as a result of the investments in Lazada, expenditure in marketing, the consolidation of Cainiao Network, and the New Retail. Therefore, the net income in 2018 has decreased by 33% when compared to 2017, explained by the non-recurring gains occurred from the selling of certain investments in 2017 (Baba, 2018).

Balance Sheet Ratio Discussion

From 2016 to 2018, the improved cash as well as quick and current rations indicated that the company’s liquidity ratios are getting stronger. Essentially, the working capital ratios such as the DPO, DIO, and DSO all showed a trend to increase. The smaller ratios of DIO and DSO in comparison to the DPO depicted that Alibaba may be issuing late payments to its suppliers to sell its inventories and collect the receivables. However, the company has a positive networking capital and as such, it has an opportunity to borrow more in order to grow its revenue despite its lessening capacity to do so. This may be attributed to the slowing growth of sales, though the cash is still increasing along with the percentage of the total liabilities.

According to leverage ratios, it is evident that Alibaba Group has used less debt as compared to its total equity and assets (Baba, 2018). In addition, the fixed coverage ratio and the cash coverage ratio increased, signifying a strengthening leverage.

As per the return on equity, there was an increase in the ROE due to the improvement in the company’s asset efficiency and the profit margin. Accordingly, the equity multiplier has decreased as indicated by the DuPont Analysis, reassuring the investors that the risk in Alibaba was reducing and that the rate of return was improving (Baba, 2018). In addition, the NWC/Sales indicated that Alibaba does not take a lot of its capital to increase its sales as it stood at 3.5% and the PPE represented approximately 14.25% of sales.

The investigation of the financial analysis by using financial ratios shows that the company is in a good state despite the 2018’s slight decrease in cash position. The return on assets stood at 8.03%, indicating that approximately 8.03%of sales was generated from the total assets. The increasing return on assets trend showed that the company is using its assets effectively. The return on equity reached 16.27%, and Alibaba’s ROE figure indicates that it is generating profits as signaled by the positive numbers. A negative ROE figure would mean that Alibaba was in fact generating losses for the units of its shareholders. As it is, currently, the company can grow further without making more investments as the asset use efficiency and operating efficiency contribute to its positive ROE.

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Statement of Cash Flow

According to the cash flow statement, there was a reduction in the short-term investments, cash, and cash equivalents from RMB220,380 to RMB205,395 million. This decrease is explained by the company’s acquisition of Intime shares, Easyhome, and investment in Wanda Cinemas of about US$1,365 million. Approximately $2,483 million was spent on investments and signified a cash outflow from Alibaba (Baba, 2018). The acquisition capital expenditures resulted in US$1,141 million of cash outflow that comprised the purchase of the right to use land and to continue the construction activities there.

Market Value Ratios

The use of ratios and other key indicators demonstrated that the Enterprise value-EBITDA ratio reached 400.95 and the Tobins Q ratio attained 6.54. The PE ratio also increased to 47.96, implying the presence of a good market outlook for the company. However, the price-sales ratio declined to 9.19, although it still signifies that the company’s stock is good for investments. The EV/EBITDA is similar to the P/E ratio and ascertains the company’s market value. The EV/EBITDA ratio shows data on the net cash and debt unlike the P/E ratio. The market ratios above reveal that the company’s performance is better than the industry average. As such, Alibaba’s investors have bigger confidence due to its positive outlook and organizational success. Alibaba has outperformed its closest competitors in China in terms of profitability. JD.com (JD) and Tencent are the main competitors for Alibaba in China while its main global competitors are Amazon.com and eBay.

Summary of Analysts’ Report

The analysis above comprised cross-examining of the historical data of Alibaba Group in the last three years. The IPO in the NYSE boosted Alibaba’s markets as it has become popular in the US market. The reviewed analysts’ reports were generated by the equity research organization called Cowen and Company and they were dated May 5, 2018 and August 21, 2018. They objectively examined the marketability of Alibaba by determining whether it is more beneficial to buy, hold, or sell its shares, choosing the former as the best option. The analysts’ reports involved the analysis of the pro-forma balance sheet, income statements, and balance sheet in 2018.

The expectation is that the online marketing services revenue will remain strong in FY 2019 whilst its profitability will be used for globalization and establishment of Cainiao and New Retail. The current target price from the report is $201 and its recommendation determines buying as the most efficient strategy (Buy Alibaba, 2018). The new investment is set to be the factor that will stimulate the growth of profits and revenue as there are high investment expectations. Cloud margins indicated a slow growth that might be explained by the strong competition in the market despite the company generating higher profits in 2018. Ant Financial contributed to the losses of RMB713m, although they are expected to revert to profitability.

Recommendation

Alibaba has a high growth rate and its strategies have a significant potential. The strong performance in the past three years attests to the strong fundamentals that the company possesses. Its rates are predicted to continue to grow, especially now that it made more investments and reached new global markets. Due to the above, the shareholders’ expectations are positive and the company is depicted to be a good investment venture. Overall, the financial ratios above prove that the company is strong and that it does not have any form of financial distress (Rains, 2018). Furthermore, investing in Alibaba is advisable due to the notable returns and its impressive growth in the past three years. From the ratios above, it is evident that Alibaba has been growing since it started. The gross margin has always been above 50%, which means that its growth rate is high. Moreover, it is a good choice of investments since its EPS is always positive and gradually growing. Based on the above, the recommendation is to buy Alibaba’s stock.