Alibaba's (BABA -1.52%) stock has garnered significant attention recently as its share price has dropped by over two-thirds from its peak. In particular, management's announcement of a new restructuring plan has caught the interest of contrarian investors seeking to capitalize on a potential turnaround.
Still, investors should be aware of the challenges associated with Alibaba's Chinese e-commerce business that could threaten the stock's investment thesis.
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Alibaba ended its fiscal 2023 year on an upbeat note
It was ugly when Alibaba reported its first-quarter results for the fiscal year 2023 ended March 31, 2023: flat top-line growth and a 53% decline in net profit. Investors expected the challenges to persist throughout the year as the company faced lockdowns and a weak economy.
Still, fiscal 2023 turned out to be better than most had expected. As a start, revenue increased by 2% year over year to 868.7 billion yuan ($126.5 billion). Operating income performed better, up 44% year over year, as the company cut costs and improved efficiency. Similarly, free cash flow improved by 74% to 171.7 billion yuan ($25 billion).
While the e-commerce business reported a marginal decline in revenue of 1%, international e-commerce, logistics, and local consumer services delivered double-digit growth for the year. So thanks to its diversified income base, Alibaba offset the slowdown in Chinese e-commerce with growth in other segments.
Granted, such a performance was still unacceptable to the giant, which was used to growing at high rates. As such, the company announced a massive restructuring plan to rekindle the growth of its businesses. Under this plan, Alibaba will break its huge empire into six segments, each forging its own path forward, including raising funds and going public.
While such a significant overhaul has pros and cons, I believe this move will bring back the focus and agility needed to improve execution. Moreover, it will free up more cash for the parent as loss-making segments can now raise funds externally.
In other words, it seems like Alibaba management has a workable strategy to bring the company back to its glory days.
But it still needs to turn around its e-commerce business
Alibaba might have a diversified business model, but its Chinese e-commerce business remains the bread and butter of the company. Historically, this business has been the primary capital provider to other loss-making businesses like Alicloud and Cainiao.
And herein lies the problem. Alibaba's e-commerce revenue has been contracting in the last few quarters. In particular, the customer management revenue -- advertising and commission income from Tmall and Taobao -- fell by 8% in fiscal 2023. The declining customer management revenue resulted from a more competitive operating environment as peers like Pinduoduo and Douying ate into Alibaba's lunch.
The silver lining is that the decline in customer management revenue moderated over the last few quarters. Revenue declined by 10% in the first quarter, but the decline has slowed to 5% in the fourth quarter. Moreover, Alibaba's online physical goods gross merchandise value grew in March, a turnaround from the earlier periods of negative growth.
Long story short, Alibaba needs to prove that it can turn around the revenue trajectory for this business in the long run. And while its recent breakout move could be the answer to this, investors should closely watch the performance of this segment in the coming quarters.
What it means for investors
Alibaba's recent muted growth performance has been hard to swallow, especially since the company has historically grown at high-double-digit rates. While Alibaba's solution to break itself down into six major business units holds promise, the turnaround work has probably just started with much more to do.
In particular, Alibaba must prove it can turn around its crown jewel Chinese e-commerce business, especially amid the increasingly competitive environment. It at least needs to halt the revenue decline for this segment.
Until then, holding Alibaba's stock remains a risky endeavor.
