Alibaba Group Holding Ltd (BABA) ADS EACH REPR 8 SHARES SPON

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Alibaba’s second-quarter results came in largely as expected. Revenue and operating profit grew by 5% to $33.7bn and $5.0bn respectively.

International Digital Commerce grew quicker than the rest of the business but also saw losses widen. Revenue for the largest segment, the domestic eCommerce channels Taobao and Tmall were flat while profits slipped by 5%. That was largely offset by strong profit growth in Cloud Intelligence of the back of a 7% increase in revenue.

Free cash flow fell by 70% to $2bn, reflecting investment in cloud infrastructure and refunds to eCommerce merchants after a change to the revenue model. Net cash stood at $19.4bn.

The company returned $14.5bn to shareholders through dividends and buybacks in the first six months of the year.

The shares were broadly flat in pre-market trading.

Our view

Alibaba is China's largest e-commerce business. But it’s battling both with a shaky Chinese economy and increasing competition. Efforts to attract and retain higher value customers has seen membership numbers at its loyalty scheme, the 88VIP club, swell to 46mn but retail is still struggling in the face of intense competition. The fight to retain market share is hurting the bottom line.

Alibaba also houses the impressive AliExpress, which connects global consumers to a vast marketplace, where they can buy directly from manufacturers all over the world. We think the international markets represent a lucrative opportunity for the group. Growth has been impressive but it’s come at the cost of heavy losses. The break-even point doesn’t look to be getting any closer. We’ll need to see a clearer path to profitability before getting too excited.

Alibaba is also looking to carve out a niche in the fast-growing world of cloud-computing. There hasn’t been a high-octane lift off. But it’s starting to make meaningful profits, which could accelerate further as it pivots to higher margin cloud services, including AI-related products which have shown triple-digit growth for five consecutive quarters. However, the unit is burning cash at breakneck speed. Growth is going to have to accelerate considerably before shareholders can be assured that this is a good use of their money.

With that in mind, it’s a good thing that the business remains cash rich and cash generative, enough for Alibaba to make generous returns to shareholders in the form of share buybacks. However, there can be no guarantee of further payouts particularly if cash flows don’t start moving back in the right direction.

Alibaba is subject to a complex influence of macroeconomic forces. On the one hand, efforts to stimulate the economy by the Chinese authorities should act as a tailwind if they have the desired effect. But the re-election of Donald Trump threatens to ignite a trade war between Washington and Beijing. Until clarity emerges about the White House’s trade policies investors are likely to remain cautious.

Alibaba’s recent business performance has been somewhat underwhelming. That’s reflected in a valuation well below the long-term average. This also suggests disappointment in failed attempts to spin off parts of the company through separate IPOs. With that distraction seemingly off the table markets are free to fully focus on stabilising the core business and embracing the more exciting growth opportunities. If management can turn things around, shareholders are likely to be rewarded for their patience but there remains a lot of execution risk ahead and there are no guarantees.

Environmental, social and governance risk

The technology sector is generally medium/low risk in terms of ESG, though some segments are more exposed, such as electronic components (environmental risks) and data monetisers (social risks). Business ethics tend to be a material risk within the tech sector, ranging from anti-competitive practices to intellectual property rights. Other key risks include labour relations, data privacy, product governance and resource use.

According to Sustainalytics, Alibaba’s management of ESG risks is average. Key risks the group’s exposed to relate to the handling of private information, specifically high volumes of Personally Identifiable Information (PII). Its use of analytics puts it at risk of data and privacy breaches. Increasing regulatory scrutiny in China increases Alibaba’s exposure to business ethics risk. Alibaba’s Chief Risk Officer oversees data protection and information security, with the privacy policy following industry best practice. Controls around business ethics risk could be enhanced through a clear governance structure and regular ethical risk assessments, which are currently lacking.

This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. It was correct as at the date of publication, and our views may have changed since then. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

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