In 2019 I pounded on the table time and time again that shares of Chinese internet giant Alibaba (NYSE:BABA) would soar above $200. In late 2019, Alibaba stock did just that. And as soon as it did, I told investors that the rally wasn’t over, and that $250 was the next stop.
A little over a month later, Alibaba has already made solid progress toward that $250 level. Gaining double-digits to around the $225 level (Editor’s Note: As of publication, Alibaba’s stock traded at $221.56).
The rally won’t stop here. Alibaba will keep pushing higher toward (and above) $250 by the middle of 2020 for two major reasons. First, the micro and macro fundamentals surrounding the company are dramatically improving, and they will continue to improve for the next few quarters. Second, Alibaba’s valuation remains discounted relative to the company’s promising long-term growth prospects.
As such, I’m sticking with this rally in BABA, and won’t consider selling until shares have jumped above $250.
Alibaba Stock Fundamentals Improve
No matter how you look at it, Alibaba’s fundamentals are dramatically improving. On the macro level, the biggest factor is deescalation in the U.S.-China trade war. Tensions between these economic powerhouses have meaningfully relaxed over the past few months, and as they have, China’s GDP growth has stabilized (6% growth in both the third and fourth quarters of 2019), the Purchasing Managers Index has rebounded (from sub-50 for several months in mid-2019, to above 50 in both November and December) and retail sales growth rates have also bounced back (from sub-8% growth for several months in mid-2019, to 8% in both November and December).
Trade war deescalation will persist for the foreseeable future because neither side wants to upset the economic balance that has materialized ahead of the 2020 U.S. presidential election. This sustained easing of trade tensions, coupled with supportive monetary policy from China’s central bank (which just dramatically expanded lending capacity throughout the country), will spark a rebound in China’s slowing economy in 2020. At the same time, it will weaken the U.S. dollar and strengthen the Chinese yuan.
That’s all positive news for Alibaba stock holders. And on the micro side, Alibaba’s margins are already materially improving as the company phases out big growth investments from 2018. This phasing out will couple with revenue growth re-acceleration in 2020 to spark even bigger margin expansion.
Concurrently, Alibaba is expanding internationally into Europe, Nintendo (OTCMKTS:NTDOY) just launched its ultra-popular Switch console in China, and Amazon’s (NASDAQ:AMZN) head cloud executive says that he sees Alibaba gaining share in China’s cloud market. New revenue from Europe, bigger revenue in China from Switch sales, and sustained revenue growth from cloud will all help Alibaba’s growth trajectory improve in 2020.
Alibaba Stock Remains Cheap
Considering how strong the Alibaba growth narrative is today and how much more this company can grow in the long run, Alibaba stock remains remarkably cheap at current levels.
The numbers are simple: Alibaba is a huge growth company. As in 40% revenue growth big. Of course, the company won’t sustain 40% revenue growth forever; growth rates will slow with scale and tougher laps. But growth drivers such as continued expansion of China’s digital economy, enterprise cloud adoption and international retail expansion should allow the company to maintain relatively big growth rates for a long time.
Analysts see Alibaba growing revenues at a 20%-plus rate for the next three years. Along those lines, I see revenues sustaining 10%-plus growth into 2025.
At the same time, Alibaba’s profit margins should run higher. Margin expansion will be supported by economies of scale, bigger revenue contribution from the higher-margin cloud segment and continued logistics cost-optimization.
Under these very reasonable growth assumptions, my long-term model on Alibaba pegs the company’s 2025 earnings potential at $20 per share. Based on a forward price-earnings multiple of 20, which is a historically average multiple for the information technology sector, that implies a 2024 price target for BABA stock of $400. Discounted back by 10% per year, that equates to a 2020 price target of $250.
Bottom Line on Alibaba
Everything is going right for Alibaba right now, and everything is projected to keep going right for the foreseeable future. Against that backdrop, the only thing that will stop Alibaba stock from going higher is valuation friction. But shares won’t run into that friction until the $250 level. For now, the BABA stock rally will stay alive.
As of this writing, Luke Lango was long BABA.