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Alibaba and the Chinese crackdowns

Richard Peterson
Richard Peterson
CEO of MarketPsych
Grant Starsiak
Grant Starsiak
Research Associate, MarketPsych Data

Has the time come to be greedy regarding Alibaba Group? Charlie Munger believes this is the case. His company, The Daily Journal, started a position in the first quarter of 2021, acquiring 165,320 shares of Alibaba worth around $37M. How could a turn in sentiment initiate bullish momentum for Alibaba share price?

  1. The 10-month 52 percent plunge in Alibaba’s share price provides a buying opportunity.
  2. Negative news and social media sentiment regarding the company is bottoming.
  3. Following Chinese administration policy changes, Alibaba offers a strengthened thesis and a favourable reward for those willing to take on the perceived risks of investing in China.

“Be fearful when others are greedy and be greedy when others are fearful.”
– Warren Buffett

Sentiment analysis on Alibaba

Investors’ risk aversion (fear) towards Chinese companies has increased due to government regulation and geopolitical tensions between the United States and China. Meanwhile, the public image of Alibaba suffered in wake of the cancellation of Ant Group’s IPO, and former chairman Jack Ma’s disappearance from the public eye certainly did not provide price support.

Consequently, share prices have plunged more than 50 percent from a 52-week-high of $319.32 to a 52-week-low of $152.90 as investor sentiment crumbled.

If sentiment is leading the price down, then it may also lead the price up. The trick is tracking changes in sentiment to provide insight on when the price could turn around.

Quantified media sentiment from news and social media tracks the net difference between all positive and negative mentions, illustrating the overall “feeling” about the company.

Use MarketPsych sentiment indicators for the creation and augmentation of trading strategies, volatility forecasting, risk management, event monitoring, macroeconomic now casting and earnings call advisory

In Figure 1 using the charting function of Refinitiv MarketPsych Analytics, we plot the Alibaba share price alongside the 90-day and 500-day averages of Alibaba media sentiment.

The green shading represents a trend of increased positive sentiment, where the average sentiment in the shorter-term (90-day) is more positive than that of the average sentiment in the longer term (500-day), while the red shading indicates higher levels of recent negative sentiment.

Figure 1: Alibaba share price vs sentiment

Alibaba share price versus the 90-day and 500-day averages of Alibaba media sentiment
Alibaba share price versus the 90-day and 500-day averages of Alibaba media sentiment

Looking at the chart, a crossover of the moving averages into green shading has historically been a good entry point to go long. We are currently in an area of pronounced red shading, coming off a period of high fear (seen here as low sentiment).

However, the 90-day moving average is basing out and closing in on the 500-day moving average. A crossover of the moving averages would be a testament to Alibaba’s rebounding short-term sentiment and may indicate a buying opportunity.

Chinese risk vs Chinese reward

The continued growth of Chinese consumption is in line with the deeper pockets of the expanding Chinese middle-class and increasing demand for consumer goods.

The negative sentiment currently surrounding the company has no bearing on the spending of retail consumers, who were directly responsible for 66 percent of total revenues in the second quarter of 2021, according to Statista.

The share price is not accurately reflecting the bullish thesis and strong fundamentals of the company. The disjunction between revenues and share price can best be described as a market inefficiency rooted in investor sentiment.

The Chinese government’s latest regulatory crackdowns targeted private education companies, sparking another wave of negative sentiment in Chinese equities illuminated in Figure 2.

The 30-day moving average of media sentiment fell well below the 90-day moving average, creating an area of red spacing mirroring the sell-off. While the chart is quite literally showing a big red flag, there may be some positive takeaways for companies like Alibaba.

Figure 2: Chinese equity price vs sentiment

China price (.SECC) versus China Stock Index Sentiment. Alibaba and the Chinese crackdowns
China price (.SECC) versus China Stock Index Sentiment

The Chinese administration forced private education companies to go non-profit, among other regulations, to defuse the hysteria surrounding after-school tutoring. Leading up to this decision, Chinese families were giving into competitive societal pressures and spending fortunes on tutoring. This limited many families to one child.

The new policy encourages families to have more children, ensuring that the Chinese government still values the growth of its nation.

This is great news for Alibaba’s intactness, given it steers clear of destabilising business ventures and continues to cooperate with regulators. On top of that, the company stands to profit from a growing Chinese consumer retail base.

Following the policy changes, Alibaba offers a strengthened thesis and a favourable reward for those willing to take on the perceived risks of investing in China.

Figure 3 illustrates the quarterly trailing 12-month total revenues for the company.

During the 52 percent decline in share price of Alibaba (BABA), the company’s top-line fundamentals continued to improve.

In the fiscal year ended 31 March 2021, Alibaba reported revenue of US$109,480M, an increase of 41 percent year-over-year. However, investors interested in bottom-line growth may have been skewed by the transitory $2.8B “anti-trust fine” that erased operating profits for the quarter ended 31 March 2020.

A fine of that size is merely a slap on the wrist, lacking the firepower to affect the fundamentals of a company with nearly $650B under current assets.

Considering Alibaba avoided the possibilities of a forced split or divestment of assets, it seems that the Chinese government is seeking respect, but still values its large companies.

Figure 3: Total Revenue (TTM)

Quarterly trailing 12-month total revenues for Alibaba
Source: Refinitiv Workspace.

While there are always risks associated with investing in Chinese stocks, at what point does the reward outweigh the risk?

Alibaba’s cooperation with regulators is critical to maintaining a positive working relationship and creating a “fair” platform for the business to continue to grow. Ultimately, the business’s ability to bring in cash from operations is not directly threatened by investor aversion toward Chinese stocks.

With Alibaba’s fundamentals intact, the pendulum of media sentiment will swing back around considering the extremely modest valuation for such a growth company.

Alibaba is trading at a historically low valuation, providing an opportunity for investors to buy shares of a large growth stock at a discount. BABA stock was trading at a price-to-cash flow (P/CF) ratio of 28.86 on 2 September 2020. The stock is currently trading at a P/CF of ~13, a 55 percent discount from recent highs.

Looking at the P/CF chart, Alibaba has never been cheaper.

Figure 4: Baba – Price / Cashflow (TTM)

Baba – Price / Cashflow (TTM)
Source: Refinitiv Workspace

Comparative analysis of Alibaba

In order to evaluate the business of Alibaba isolated from the fear surrounding it, an investor might compare valuation metrics with a similar company.

Amazon is a fair company to conduct such comparative analysis due to similarities in growth model, industry and market capitalisation.

Figure 5 shows the decline of the P/CF ratio for BABA over the past year, alongside the change in P/CF ratio for the American e-commerce giant Amazon (AMZN).

Historically, these companies tend to trade at similar P/CF ratios with high correlation. However, investors are willing to pay a little more for Amazon’s cash flows because of more diversified revenue streams and better brand reputation.

Nonetheless, the chart illustrates the effect of increased investor risk aversion of Alibaba, maintaining Amazon as the control group.

Figure 5: Price / cash flow (TTM)

 Price / cash flow (TTM) for BABA
Source: Refinitiv Workspace

The divergence in P/CF valuation between both companies has been growing for months.

On 1 September 2021, Alibaba closed at a P/CF ratio of 14.09 while Amazon closed at a P/CF ratio of 29.70. Although they are similar companies, Amazon has not been subject to a decrease in market capitalisation due to a barrage of negative media.

Let’s take a look at what investors might have paid for Alibaba on 1 September 2021, given its operational cash flows were valued like Amazon’s:

(Amazon’s Price-to-CF / Alibaba’s Price-to-CF) * (Alibaba Share Price) = Value

(29.70 / 14.09) * $173.25 = $365.19

On a P/CF basis, Alibaba was trading at a 53 percent discount to Amazon. Taking a modest 25 percent discount off the $365.19 comparative valuation leaves us with a share price of $273.89.

This valuation certainly holds weight considering previous prices paid for the cash flows of both companies. On 2 November 2020, Alibaba was trading at a higher P/CF of 28.12 to Amazon’s 27.26.

Alibaba is a pure value play at any price below $200.00, and an easy way to capitalise on negative sentiment.

Investing with precision

Considering the proximity to a bullish crossover of the sentiment moving averages, the barrage of negative media sentiment regarding regulatory risks, and discounted valuation in comparison with Amazon, Alibaba may be one news catalyst away from the beginning of an uptrend.

Warren Buffett propagated the idea of buying when others are fearful. Quantified media sentiment opens the door for like-minded investors to employ this approach to investing with precision.

Use MarketPsych sentiment indicators for the creation and augmentation of trading strategies, volatility forecasting, risk management, event monitoring, macroeconomic now casting and earnings call advisory