Alibaba: Can't Stop Delivering

Core Commerce growth remains solid despite maturity concerns.\n

Cross-border, overseas, and lower-tier region showing signs strength.\n

Reiterate our bullish view and $200/share target.\n

Alibaba (BABA) delivered a solid September quarter despite the maturing eCommerce market in China, overseas competition and a weak macro with both revenue and EPS 2% and 23% above consensus, respectively.

The stock reacted to the upside following the print but has given back all of the gains partially due to the uncertainties with the trade war. We prefer to ignore the noise the focus on the fundamentals. The focus going forward will be how BABA's upcoming Singles Day (November 11th) will perform given the concerns on the soft macro and competitive pricing. In one of the rare occasions, all of BABA's eCommerce platforms (both China and abroad) will participate in this year's Singles Day. If the result is better than expected, we can see the stock trade higher until the end of the year.

BABA remains our top pick on amongst the Chinese internet companies given its competitive ecosystem and one of few Chinese companies that could potentially become a global contender. We reiterate our bullish view on the stock and our $200/share target price.

China commerce retail revenue growth of 40% remains one of the best-in-class given the maturity of the eCommerce market. Annual active buyer of 693m was a 15% growth from a year ago, with mobile MAU growing 18% YoY to 785m, suggesting lower-tier cities penetration initiative has effectiveness on user acquisition. Management pointed out Taobao DAU growth accelerated over the past six months due to effective user targeting and increasing engagement. We would like to see higher MAU/active users as we think this is a good indicator of the overall engagement on the platform.

Customer Management Revenue (CMR) grew 25% YoY while commission revenue grew 24% YoY. Much of the CMR revenue growth was due to higher pricing rather than volume, which we find somewhat concerning as it suggests that clicks per user remain soft.

Local consumer services revenue grew 36% driven by platform commission. Notably, 39% of the food delivery customers came from the Alipay mobile app, suggesting that Alipay has been effective in cross-selling Ele.me. Given that both Ele.me and Meituan are largely duopolies of the food delivery market, we expect both parties to remain rational on subsidies which should bode well for margins in the near-term (see: Meituan Dianping: Rational Environment Driving Q3').

Cloud revenue growth of 64% was driven by a slight increase in ARPU. Alicloud remains a dominant player in China’s cloud market with 59% of the listed companies in China are Alicloud customers. However, adj. EBITDA margin of -6% this quarter suggests that the market remains hyper-competitive and profitability will take some time.

New Retail the Steady Eddy

In our first note on BABA (see: Alibaba: New Growth Drivers In A New Era), we pointed out that BABA’s New Retail strategy is becoming increasingly important as a future revenue driver given the maturity of the eCommerce landscape in China. Although this segment continues to account for a small portion of the overall revenue, we feel that its growth trajectory remains in the right direction. Freshippo store count increased to 170 this quarter, adding 20 stores, compared with 15 last quarter. Profitability remains steady with stores that have been in operation for over a year achieving EBITDA breakeven during the quarter. Given that much of the retail sales remains in the offline segment, leveraging its digital scale and ecosystem to gain more of the offline wallet share will become a key determinant of BABA’s medium-term growth trajectory.

Lower-tier cities penetration remains intact

During the quarter, BABA’s engagement level within the lower-tier cities is seeing good results with higher buying frequency and accelerate order growth. More importantly, new users from these lower-tier regions are generating roughly RMB2,000 in annual spending which is on par to that of Pinduoduo’s (PDD) average annual spending per user and we believe that BABA has greater further room to take market share away from PDD over time as BABA leverages its scale in both products and targeted recommendation to attract buyers and encourage spending.

Cross-border and international eCommerce’s rising roles

We believe that cross-border and international eCommerce will play a bigger part role in the BABA equation as domestic e-commerce faces the maturity headwind. Acquiring the cross-border eCommerce business from NetEase (NTES) (see: NetEase: Think Global, Act Global) is advantageous for both parties as BABA adds a strategic puzzle within its eCommerce ecosystem while NTES unload noncore asset to focus on gaming. Given that Tmall Global and Kaola have little consumer overlap, we expect it to further enhance BABA’s cross-border offering to the Chinese consumers to drive revenue while integrating key components such as technology, procurement, and supply chain will likely to drive long-term margin accretion.

Meanwhile, in the ASEAN, Lazada’s operating metrics remain solid with order growth more than doubling for the fourth straight quarter, although we remain cautious about the competitive dynamic within these regions. User acquisition remains the single biggest priority for BABA but it appears that local incumbents remain at an advantage in both consumer connection and execution. That said, we would not rule out another major acquisition for BABA on the international side in an effort to reach global scalability. In the long term, assuming an easing of the trade war, we would not rule out the possibility of BABA acquiring eBay (EBAY) to solidify its marketplace in North America so it can 1) attract more buyers into its ecosystem, and 2) shift the SME merchants from Amazon’s (AMZN) FBA segment to the BABA-owned eBay platform. Of course, this scenario will materialize only if the trade tension eases.

I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.