Alibaba's (BABA 2.03%) stock is up more than 20% this year as China relaxed the zero-COVID restrictions that were throttling its economic growth. Is it too late to buy Alibaba right now, or does it still have more room to run this year?
Why did Alibaba's stock initially collapse?
Alibaba's stock closed at its all-time high of $317.14 on Oct. 27, 2020. At the time, many investors considered it to be a solid long-term investment because it was China's largest e-commerce and cloud platform company.
But two years later, Alibaba's stock dropped below its IPO price of $68. That collapse was caused by a painful streak of regulatory, macroeconomic, and competitive challenges.
Image source: Alibaba.
First, Alibaba was hit by an antitrust probe in China, which resulted in a $2.75 billion fine and new restrictions on its e-commerce business. The Chinese government also fined Alibaba for its previously unapproved investments and acquisitions, and it indefinitely suspended the IPO of Alibaba's fintech affiliate Ant Group. U.S. regulators also threatened to delist shares of Chinese companies if they didn't open their books to independent auditors.
Meanwhile, China's economic growth cooled off, and that slowdown was exacerbated by the unpredictable zero-COVID lockdowns. The government-imposed restrictions on Alibaba's e-commerce business -- which barred its exclusive deals with merchants and excessive promotions -- also made it easier for smaller e-commerce players like JD.com (JD 4.90%) and Pinduoduo (PDD 2.59%) to catch up. The growth of Alibaba Cloud also decelerated amid those macro headwinds.
All those headwinds made Alibaba a tough stock to love. In fiscal 2021 (which ended on March 31, 2021), its revenue and adjusted earnings per share (EPS) rose 41% and 23%, respectively. But in fiscal 2022, its revenue only grew 19% as its adjusted EPS dropped 19%. For fiscal 2023, analysts expect its revenue and adjusted EPS to rise 10% and 6%, respectively.
Are Alibaba's valuations still attractive?
Alibaba's high-growth days might be over, but its stock looks cheap at 12 times forward earnings. JD.com and Pinduoduo, which are both growing faster than Alibaba, trade at 20 and 22 times forward earnings, respectively.
Alibaba's stock is still trading at a discount because the regulatory headwinds haven't fully dissipated yet. Over the past few months, the Chinese government acquired "golden shares" (which have special voting and veto rights) in two of Alibaba's domestic businesses -- Youku Tudou's film and TV unit, and a research and development division called Guangzhou Lujiao. That creeping influence indicates the Chinese government still plans to tighten its grip on Alibaba's sprawling digital ecosystem.
The Biden administration's ban on all advanced chip sales to China, which took effect last October, also barred Alibaba from licensing new Arm-based server chip designs from SoftBank's (SFTB.Y 1.34%) Arm Holdings. Those restrictions could potentially curb the growth of Alibaba's cloud business and reduce the effectiveness of its artificial intelligence algorithms.
As for the delisting threats in the U.S., they still haven't been resolved, even though China started to allow American regulators to review Chinese audits of those companies last December. That falls short of the Public Company Accounting Oversight Board's demand for unrestricted access, so Alibaba and its peers could still be delisted if a deal isn't reached.
But don't overlook its other near-term problems
Even if we look past all those regulatory challenges, Alibaba's near-term prospects look grim. Its sales during Singles Day in 2022 -- the Chinese equivalent to Black Friday, which occurs around Nov. 11 -- stayed roughly flat from the previous year. JD's and Pinduoduo's superior growth also suggests that many of Alibaba's wounds were either self-inflicted or caused by the government, instead of the broader macroeconomic and COVID-related headwinds.
As the growth of Alibaba's Chinese commerce business decelerates, it's relying more on its lower-margin businesses -- including its direct sales platforms, logistics network, brick-and-mortar stores, and overseas marketplaces (including Lazada and Trendyol) -- to drive its sales growth. That's worrisome because Alibaba generates all of its profits from its commerce segment -- which in turn subsidizes the expansion of its unprofitable cloud, digital media, and innovation initiatives divisions.
After taking all these issues into account, I simply can't recommend buying Alibaba as a post-COVID reopening play in China. If you want some exposure to that same trend, Pinduoduo -- which is better streamlined than Alibaba and faces fewer regulatory headwinds -- would arguably be a much better play.
