3 Red Flags for Alibaba's Future

Alibaba's (BABA 6.38%) stock price sank 9% on Nov. 16 after the Chinese e-commerce and cloud leader posted its latest earnings report. For the second quarter of fiscal 2024, which ended on Sept. 30, its revenue rose 9% year over year to 224.8 billion yuan ($30.8 billion), but that number missed analysts' expectations by $230 million.

Adjusted net income grew 19% to 40.2 billion yuan ($5.5 billion), or $2.14 per American Depositary Share (ADS), and cleared the consensus forecast by $0.05. Those headline numbers looked stable, but a deeper dive reveals three red flags.

Image source: Alibaba.

1. Another quarter of decelerating growth

When Alibaba's revenue rose 14% year over year in the first quarter of fiscal 2024, the bulls rejoiced because it represented the company's first quarter of double-digit revenue growth since the third quarter of fiscal 2022 (which ended in December 2021). That's why it was disappointing when Alibaba only reported 9% growth in the second quarter.

Alibaba restructured its business into six new segments starting in fiscal 2024:

1. Taobao and Tmall (46% of its revenue in the first half of the year)
2. International digital commerce (10%)
3. Cloud intelligence (11%)
4. Cainiao smart logistics (10%)
5. Local services (7%)
6. Digital media and entertainment (2%)

That restructuring freed each group to operate independently under their individual CEOs, pursue funding from external investors, and potentially be spun off through new initial public offerings (IPOs).

But in the second quarter, the only business that generated accelerating revenue growth was Alibaba's international digital commerce division, which handles Lazada in Southeast Asia, Trendyol in Turkey, and its cross-border marketplace AliExpress. All of its other businesses suffered significant slowdowns.

Data source: Alibaba. YOY = Year over year. Growth is calculated in RMB terms.

The Taobao and Tmall Group's slowdown to single-digit growth was especially disappointing since it indicates its largest Chinese marketplaces still face tough macro, competitive, and regulatory headwinds. Pinduoduo, one of Alibaba's largest Chinese competitors, generated 66% year-over-year revenue growth in its latest quarter.

The cloud and intelligence group's deceleration is also worrisome because it suggests Alibaba is struggling to stay ahead of Huawei, Tencent, Baidu, and other smaller players in China's crowded cloud market.

2. Alibaba will no longer spin off its cloud division

Alibaba initially claimed it would spin off its cloud division in an IPO. It also said that after Daniel Zhang stepped down as Alibaba's CEO, he would stay on as the CEO of the new cloud intelligence unit and lead it through its public debut.

But after Eddie Wu took the helm as Alibaba's new CEO this September, Daniel Zhang unexpectedly relinquished his position as the CEO of the cloud unit. That departure raised doubts regarding its future as a stand-alone company.

That's why it wasn't surprising when Alibaba announced it no longer planned to spin off the cloud unit in an IPO. During the conference call, Chairman Joe Tsai attributed that decision to the "uncertainties created by recent U.S. export restrictions on advanced computing chips." Tsai said that instead of taking it public, it would "focus on developing a sustainable growth model" for the business "based on emerging AI [artificial intelligence]-driven demand for networked and highly scaled cloud computing services."

That decision is the latest indicator that Alibaba's planned IPOs for its individual business groups are off to a rocky start. Its Cainiao logistics group is still on track for a future IPO in Hong Kong, but the company also postponed a planned IPO for its Freshippo grocery unit earlier this year after it fell short of its targeted valuation.

3. Alibaba's focus on buybacks and dividends

As Alibaba's growth revenue cooled off, it focused on stabilizing margins and increasing buybacks. It bought back $1.7 billion in shares in the second quarter and has $14.6 billion remaining in its current buyback authorization through March 2025. It also approved an annual cash dividend of $1 per ADS, which will be paid out in January. At $79 per share, that translates to a forward yield of 1.3%.

Buybacks and dividends are certainly shareholder-friendly strategies, but they often indicate a company's high-growth days are over. If Alibaba still had room to expand its e-commerce and cloud ecosystems, it would have allocated all that cash toward investments and acquisitions instead of buybacks and dividends.

Unfortunately, China's antitrust crackdown on Alibaba now bars it from making any big investments without the government's approval. Those shackles could make it difficult for the company to compete against Pinduoduo, JD.com, and other companies across China's saturated e-commerce sector.

Don't overlook its underlying strengths

Alibaba faces a lot of challenges, but margins are still expanding and its stock looks undeniably cheap at 12 times forward earnings. The growth of its international marketplaces and AI-oriented cloud services could also stabilize its business as the macro environment improves. Therefore, I wouldn't be too bearish on Alibaba over the long term -- even though these three red flags could limit its near-term gains.