Alibaba: With A 22% FCF Yield, Growth Is No Longer Needed

February 15, 2024

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Alibaba Group Holding Limited (NYSE:BABA) has suffered a staggering 77% decline from its bubble peak just over three years ago, even as the company's sales, earnings, and net cash pile have continued to rise, albeit more slowly than investors had expected. As a result, the stock now offers a 13% free cash flow yield, and this rises to 22% when compared against its enterprise value due to the company's impressive net cash position. While its free cash flow may paint a favourable picture of earnings due to high stock-based compensation, the company's valuations make it an enormous outlier in the global mega cap tech space. With $35bn in buybacks slated over the next three years, now equivalent to almost 20% of the stock's market cap and almost one-third of its enterprise value, BABA no longer needs any growth at all to deliver strong returns to shareholders.
Alibaba Market Cap (Bloomberg)
From Growth Stock To Free Cash Flow King
At the height of its bubble in October 2020, BABA had a market cap of $839bn in October 2020, making it one of the largest companies in the world, with investors widely expecting it to grow into its 60x earnings multiple. Alibaba's fall from grace in the eyes of investors has reflected the collapse in earnings expectations for the company. Having clocked a 5-year CAGR of 44% for sales and 37% for earnings in the years preceding the peak, investors had extrapolated this growth and the stock enjoyed a 99% buy rating by Wall Street analysts. Today, sales growth expectations over the next 12 months sit at just 7% and the buy rating percentage has fallen to 81%, which is the lowest figure in the stock's 10-year history.
Wall Street Analyst Recommendations (Bloomberg)
However, at current valuations, the company does not need to grow at all for shareholders to receive strong returns. With free cash flows of $23.2bn over the past 12 months, the trailing FCF yield is an impressive 12.8%, up from 3.0% in 2020. Over this period, BABA's net cash pile has continued to grow and now sits at $76bn, meaning that when measured against its enterprise value, the stock now yields 21.8%.
FCF Yield And FCF Yield With Enterprise Value (Bloomberg)
It should be noted that Alibaba's stock-based compensation is extremely high, having been equivalent to around 25% of free cash flow in recent years. The free cash flow figure may therefore overly inflate the company's sustainable cash generating ability, and equity sales during any market rally could dampen returns. However, it is no surprise therefore that management has committed to using these cheap valuations to return cash to shareholders. It announced an additional $25bn in buybacks following its earnings results last week, bringing the total allotted to its share repurchase program through the end of March 2027 to $35.3bn. Even assuming that stock-based compensation maintains its current pace and results in $15bn in share issuance over this period, at current market valuations the share count would fall by around 11%, raising per share earnings and free cash flows by over 12% even assuming no growth in the nominal figures. This is an astonishingly large percentage buyback commitment that should put a floor under prices even if earnings and free cash flows stagnate over the coming years.
Uniquely Undervalued In The Mega Cap Tech Space
The chart below shows the PE ratios and EV/EBITDA ratios for the top 20 largest tech stocks by earnings globally. Alibaba trades at around one third of the median PE for this group, and one quarter of the median EV/EBITDA. While some degree of China discount is surely deserved due to regulatory risks, these risks were also apparent three years ago when Alibaba was one of the most expensive tech stocks in the world.
Valuations Of Top 20 Global Tech Stocks By Earnings (Bloomberg)
The next chart shows the same data on a scatter plot, along with Alibaba's valuations at its October 2020 peak. The stock has moved from being one of the most expensive in this group to by far the cheapest in just over three years.
Equity Valuations Among Top 20 Global Tech Stocks By Earnings (Bloomberg)
Upside Momentum Could Build Above $78
Any positive sign on the growth front could trigger a huge upside reversal in BABA, given how depressed sentiment has become towards Chinese stocks. Asset managers globally have shunned Chinese stocks in favour of the US, but recently the market has seen a surge in call option buying. This suggests that any upside momentum in Chinese stocks could be met with a large wave of forced buying by option sellers, creating a price spike. A move back above the pre-earnings peak of $78.34 would be a very bullish sign as this marks a key pivot area for the stock as well as down trendline resistance from the August 2023 highs.
BABA Stock Price (Bloomberg)
Alibaba's stock price has seen a historic de-rating over the past three years to the point where its trailing free cash flows are now 22% of its enterprise value, suggesting investors are completely discounting any prospect of growth. Even if growth remains stagnant, the huge cash pile and commitment to buybacks should allow the stock to post strong returns over the coming years. Given the widespread bearish sentiment towards Chinese stocks in general, any upside momentum in BABA could become self-fulfilling, with $78 a key area to watch.
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.

This data comes from MediaIntel.Asia's Media Intelligence and Media Monitoring Platform.

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