Alibaba | Fundamental Analysis | MUST READ ⚡️

Alibaba shares fell 11% last week after the Chinese e-commerce and cloud leader released its Q2 earnings report. The company's revenue increased 29% YoY to $31.1 billion, $673 million less than forecasts. Excluding the consolidation of hypermarket operator Sun Art, the company's revenue would have grown only 16%.

Adjusted earnings dropped 38% to ¥11.20 ($1.74) per ADS, which was not in line with the analysts' expectations by $0.19. Under generally accepted accounting principles (GAAP), which include many investment-related losses, adjusted earnings fell 81% to ¥1.97 ($0.31) per ADS.

These numbers look terrible, but have investors overreacted and created a perfect opportunity for more calm investors? Let's break it down.

Alibaba gets most of its revenue and all of its profits from its trading segment, which operates online marketplaces (Taobao, Tmall, and others), physical stores, cross-border and overseas markets, and the logistics arm of Cainiao.

Alibaba Cloud, China's largest cloud infrastructure platform, is generating a growing percentage of the company's revenue. This segment is still loss-making on GAAP, but it makes a very small profit on adjusted earnings before interest, taxes, and depreciation (EBITA).

That growth rate seems healthy, but the retail segment has relied massively on the extension of its lower-margin retailers, online stores, cross-border and logistics businesses to offset the slowdown in its higher-margin online Taobao and Tmall stores in China.

This pressure has caused the merchant segment's adjusted EBITA margin to fall sharply over the past year, even as cloud segment margins have recovered.

This decline is likely to continue as new antitrust rules block Alibaba from making exclusive deals with merchants. Fierce competition from JD.com, Pinduoduo, and other rivals will increase this burden and make Alibaba rely even more on expanding its low-margin platforms to attract more buyers.

This is worrisome because profits from Alibaba's commercial segment support the expansion of loss-making cloud technology, digital media and entertainment, and innovation initiatives. The loss of these profits could notably diminish Alibaba's capacity to develop its ecosystem.

Alibaba's profit miss and shrinking margins were already disappointing, but the company's forecasts were even worse. Back in May, Alibaba said its revenue would grow by about 30% in fiscal 2022. It reiterated that forecast in August.

But this time, it lowered that forecast to growth of only 20% to 23%. Management attributes this significant decline to lower commercial revenues from both direct sales and customer management (listing fees and commissions).

By contrast, experts forecast JD and Pinduoduo to increase their revenues by 29% and 83%, respectively, this year.

During the conference call, CFO Maggie Wu explained the slowdown by competition from "more players" in China's e-commerce sector and suggested that these rivals are "raising investments to acquire users."

On the other hand, Wu said the company's international business, which mainly includes the Southeast Asian trading platform Lazada, the Turkish trading platform Trendyol and the cross-border trading platform AliExpress, is still showing "strong growth." Nevertheless, she did not address Lazada's continued loss of the Southeast Asian market to Sea's Shopee over the past four years.

Alibaba trades at just 18 times projected earnings. JD trades at nearly 40 times projected earnings, and Pinduoduo has a P/E ratio of nearly 90.

Some influential investors, including Charlie Munger, think that Alibaba's market dominance and lower valuation make it an undervalued growth stock. But it's hardly a bargain, and here is why: its main profit engine is slowing, its margins are falling, and it has too many rivals in China.

All of these problems, as well as unresolved regulatory problems with Chinese stocks listed in both the U.S. and China, make Alibaba seem like a value trap.

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