Alibaba (NYSE:) should be able to deliver strong growth in 2020 as a number of macro obstacles fade away. If Alibaba stock is valued on the fundamentals of the company, it should get a much better valuation multiple. One of the biggest challenges BABA faces is the ongoing trade war between the U.S. and China. There are strong signs that there will be a trade truce and a possibility of “phase one” trade agreement.
The phase one agreement will include reversing some tariffs on both sides. This should boost consumer demand in China and also improve the sentiment around Alibaba stock. Alibaba has reported 40% year-over-year revenue growth in the latest quarter and in the past few quarters. It is also showing strong growth in the cloud segment with 64% YoY growth. The trade truce and a steep growth trajectory make Alibaba stock a strong buy for 2020.
Reduction in Trade Tensions
Recent announcements from both the U.S. and Chinese administration signal strong support for a “phase one” trade agreement. This first phase will include a rollback of some of the major tariffs. An important date to watch is 15th December when an additional round of tariffs will be announced. These tariffs are more broad-based and could hurt consumer sentiment in both the U.S. and China. In order to prevent these tariffs, negotiators on both sides are looking to secure a phase one agreement as soon as possible.
After the holiday season, we should see a kick start of the presidential election cycle of 2020. According to Reuters, the current administration is looking to show progress in the trade talks with China. This should reduce the trade rhetoric in 2020 and improve the market sentiment toward a broader trade agreement.
BABA would be one of the biggest beneficiaries of a trade truce. Since the first announcement of trade tariffs in March 2018, BABA stock has been gripped by a bearish sentiment that has led to lower price growth in the stock. On the other hand, its trailing twelve-month revenue has increased by 70%, while earnings per share has increased by 135% during this time period.
A definite signal about the completion of a “phase one” trade agreement should provide an instant boost to Alibaba stock and improve the bullish estimates for the company.
Alibaba Stock: Improvement in Fundamentals
Alibaba continues to show rapid growth in key metrics. As mentioned earlier, the revenue growth in the past 18 months has been good. In the latest quarter, Alibaba reported 40% growth in core commerce and 64% growth in its cloud computing segment. At the current pace, Alibaba Cloud should be able to reach a $10 billion annualized revenue rate by the end of 2020. This would improve the standalone valuation of the cloud segment and Alibaba stock.
The EBITA margins of Alibaba Cloud in the latest quarter were down 6%. Currently, Alibaba’s management is focusing on revenue growth in this segment. As the revenue base of cloud computing expands, we should see a rapid increase in margins. The trailing of Amazon’s (NASDAQ:) AWS is 25%. Hence, there is an over 30 percentage point gap between the margins of AWS and Alibaba Cloud. AWS reported a growth of 35% in the recent quarter, which is lower than Alibaba Cloud.
As the revenue gap between Alibaba Cloud and AWS decreases, we should see a reduction in the margin gap between these two cloud players.
Alibaba’s core commerce services continue to show strong growth. Despite the larger size, Alibaba’s revenue growth has been higher than JD.com (NASDAQ:), its main competitor in China. This shows the wide moat enjoyed by Alibaba’s platform and its ability to monetize different services effectively.
Impact on Valuation
Strong fundamentals and a trade truce should provide a major boost to BABA stock in 2020. The stock is trading at close to 22 times its trailing twelve months price-to-earnings ratio. This is quite low for a company showing 40% revenue growth and significant upside from its cloud operations. The forward EPS estimates for Alibaba have also increased rapidly in the last few months. This makes BABA stock more attractive as a long-term buy and hold investment.
Alibaba stock is trading at a reasonable valuation and has a number of tailwinds that can lift the stock in 2020. The stock is a good buy from both fundamental metrics as well as the macro trade situation.
Alibaba stock has given great returns since the start of the trade tensions in March 2018. During this time, the company has improved its trailing twelve-month revenue by 70% and EPS by 135%. There are strong signals that a trade truce will be declared by the signing of a “phase one” trade agreement. This will remove the bearish headwinds for Alibaba stock and allow the company to be valued at its fundamental performance.
Alibaba is not only showing YoY growth of 40%, but it is also increasing the ecommerce market share in China. The revenue growth in Alibaba has been higher than JD for a number of quarters. This should allow the company to launch new services and improve its margins. I believe that BABA stock can be a big winner in 2020 as it would be valued on fundamental growth prospects instead of fears about the trade war.
As of this writing, Rohit Chhatwal did not hold a position in any of the aforementioned securities.
The post appeared first on InvestorPlace.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.