Alibaba trade idea

Alibaba (NYSE:BABA, HKEX: 09988.HK) will announce its June quarter 2020 results on the evening of August 20, 2020 (Hong Kong time).

In the fiscal year 2020 (2019 April to 2020 March), Alibaba has achieved a milestone of more than one trillion USD in the gross merchandise volume (GMV). This article will examine a few key points to be watched before its new quarter announcement.

Key operating aspects to watch in its new quarter result

1. Despite the impacts from Covid-19 on retail consumption during Q1 2020, the revenue growth of Alibaba’s core commerce segment was still strong with the addition of their new retail and direct sales business (fresh food and grocery business). In June 2020, consumer discretionary sector has also mostly recovered in China, will Alibaba see higher percentage growth in its core commerce segment?

In the 1st quarter of 2020, most of the consumer discretionary sectors were dragged into the mire as individuals’ consumption needs turned to daily necessities. Against such a backdrop, Alibaba seized the opportunity to expand the coverage of its core commerce business to include daily necessities like fresh food and grocery products. This has proven great success in the first three months. The direct sales business under Alibaba’s brands, Freshippo and Tmall supermarket saw rapid growth and recorded a 88% revenue YoY increase just in the 1st quarter of 2020

In the next quarter, the consumer discretionary sector is believed to make a comeback and this should further increase the revenue growth of Alibaba’s core commerce segment.

2. Alibaba’s three other business segments, notably cloud computing, digital media and entertainment, and innovation initiatives, have all recorded net operating loss for the past three financial years. For a change, will the new quarter record operating profit in any of the three segments?

As we can see from the tables below, in the Alibaba quarter and yearly reports, these segments have recorded operating losses continuously and have impacted the overall profitability of Alibaba. A change in the result to any of these segments can improve Alibaba’s price, one to watch.

3. The gross margin has reduced gradually following the increase in direct sales. As fresh food and daily necessities largely rely on a direct sales model, how will Alibaba cope with the decreasing gross margin in its future business operation?

Alibaba has always adopted a different business model as compared to Amazon, taking on a sales agent model while the latter, an economics of scale model. To explain further, Amazon is basically the online version of Walmart, which buys a big proportion of products from suppliers and then reselling them to end customers, while Alibaba only provides the platform for merchants and customers to deal by themselves. As a result, Alibaba could potentially enjoy higher gross and operating margins as compared to Amazon. However, with the advent of Covid-19 and more people purchasing their fresh food online, Alibaba started to adopt a direct sales model, akin to Amazon’s economics of scale model. And a direct sales business would significantly increase the cost of revenue and reduce the gross margin, as we can see in the below table.

It will be interesting to see how Alibaba’s latest gross margin will fare as we see increasing demand for online purchases of daily necessities in China, and also the other parts of the world.

4. The ever-increasing user base is crucial to most technology companies. How many more users can Alibaba’s commercial platforms (including Taobao, Tmall, etc) still attract? How can the company effectively convert registered users to active shoppers?

In Alibaba’s latest fiscal year financial report ending in March 2020, Alibaba has mentioned that its retail shopping platforms, which mainly include Taobao and Tmall, have over 300 million daily active users in the month of March 2020. An expanding user base will definitely bring about more transactional opportunities between customers and merchants, which would potentially boost Alibaba’s revenue in its core commerce segment. To leverage on the increasing time spent of users on the platform and to get more users to stay active, Alibaba has also imbued its e-commerce platforms with interactive and social elements including merchants’ live streaming, short-form videos, interactive games, etc.

Notably, for an e-commerce platform, a client base of three million users is not a small number, the upside potential of acquiring more users may be limited for Alibaba. It will be crucial for the company to seek possible avenues to grow their user base, one to watch in the new quarter result.

Possible risks

The current risk factors are rather independent from fundamentals of the economy, with the outlook showing correlation to market sentiments. If the market view radically changes, Alibaba’s stock price may follow suit market sentiments to rise or fall.

A second wave of the virus is still possible and the lockdown and social distancing measures are likely to be put in place again. This will definitely impact end users’ consumption and buying habits of discretionary products, which may result in a dip of performance in future.

How to manage risk?

Investors should set a percentage to stop loss (typically at 10% of the buying price). If the short term moving average line (e.g. 20-day) crosses from above the long term moving average line (e.g. 60-day), it is possible that the stock price will continue to drop. It is strongly recommended to stop loss in a timely manner.

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