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Alibaba - higher costs drag profits down

Second quarter revenue was flat year-on-year at $30.7bn.

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Second quarter revenue was flat year-on-year at $30.7bn. That came as growth in some of the smaller business segments, such as cloud, were more than offset by a 1% decline in the much larger China Commerce segment.

Operating income fell 19% to $3.7bn, largely a result of higher costs as an increased portion of sales came from lower margin businesses.

The group spent $3.5bn on share buybacks over the period and has $12bn remaining, of the current $25bn repurchase programme, to use before March 2024.

Plans are underway to add Hong Kong as another primary listing venue, in the hopes of expanding the investor base.

The shares rose 5% following the announcement on 4 August.

View the latest Alibaba share price and how to deal

Our View

It would be shorter to explain what Alibaba doesn't do. This Chinese giant is responsible for multiple businesses across e-commerce, digital media and entertainment, logistics and cloud computing, to name just a few.

The biggest segment, by some way, is China Commerce, with just shy of 70% of total revenue in the quarter just gone. China Commerce includes Taobao, which is China's largest shopping website, and TMall, which sells higher-end and branded goods.

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.

There are challenges. Alibaba has said it's "prudent" not to give financial guidance for the current year, because of the ongoing impact of Covid-19. China has been hit by renewed lockdowns in major cities since spring, meaning supply chain and logistics are challenging.

The worst of the effects for profits are being offset by cost cutting efforts. This is admirable, but not a permanent solution. Volumes will have to pick up the slack eventually.

And keeping sales on an upwards trajectory well into the future is the responsibility of international markets.

Alibaba's domestic operations are facing a slowdown, relating to a weaker economic outlook, a government tech-crackdown and increased competition. The group's responded by doubling down efforts to expand in South Asia, an area with good growth potential.

We'd be remiss not to mention the Cloud business too. It's a small fish for now, bringing in less than 10% of total revenue. But ongoing investment means only a small drop of this is making its way to profit.

It's a great industry to be in, but Alibaba's cloud business lags some of the big global competitors. The regulatory environment has been described as an "onslaught", making rapid tech growth more difficult. For now, Amazon and Microsoft's Cloud businesses look a lot more compelling.

A shining positive is Alibaba's net cash hoard of $45bn. This gives it enormous flexibility in tough times, as well as the ability to throw money at expansion efforts.

Alibaba's scale and usership base is formidable and it has the foundations to do well. However, there are some very real headwinds blowing.

If international expansion efforts take off at the required speed, Alibaba could unlock enormous growth, but that's a very big 'if'. Concerns are reflected in a price to earnings ratio of around 12, which could be compelling - only for those prepared to take on some increased external risk.

Alibaba key facts

All ratios are sourced from Refinitiv. Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

Second Quarter Results

Revenue from China Commerce segment fell 1% to $21.2bn. That was driven by a 2% decline in sales from the retail business to $20.5bn, as a 10% fall in customer management was only partially offset by a rise in direct sales & others. Wholesale revenue rose 26% to $740m. A drop in margins meant underlying cash profit (EBITA) fell 14% to $6.5bn.

International Commerce saw revenue rise 2% to $2.3bn. The retail arm posted a revenue drop of 3% to $1.6bn due to supply chain disruptions and a drop in orders of AliExpress, an online retailer. Wholesale revenue again outperformed, with revenue up 12% to $736m. There was an underlying cash loss (EBITA) of $234m, largely a result of higher losses from the e-commerce platform, Trendyol.

The Cloud division saw revenue rise 10% to $2.6bn, after excluding services provided to other Alibaba businesses. Revenue growth reflected the ongoing recovery of financial services, public services, and telecommunication industries. Underlying cash profit fell 27% to $37m, due to higher investment in technology.

Local consumer services and Cainiao both posted revenue growth of 5%. Digital media & entertainment and Innovation initiatives & others saw revenue fall 10% and 30% respectively.

Free cash flow rose 7% to $3.3bn and the group had a net cash position at the end of the period of $45.0bn.

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.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.

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Written by
Matt Britzman
Equity Analyst

Matt is an Equity Analyst on the share research team, providing up-to-date research and analysis on individual companies and wider sectors.

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Article history
Published: 5th August 2022