Alibaba Stock: It Could Get Worse (NYSE: BABA)

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Robert Road

from Alibaba (NYSE: BABA) stocks are down 35% year-to-date, but the decline may not be over yet. The latest data reveals that short-term interest in the stock soared 7% over the last reporting cycle. This rapid and short accumulation suggests that market participants might perceive the stock to be overvalued at current levels and likely anticipate that it will fall further in the days and weeks to come. This should encourage Alibaba investors to reevaluate their investment thesis and avoid trying to catch falling knives. Let’s take a closer look at all of this.

High short circuit activity

Let me start by saying that short interest is basically the total number of short positions that are open and have not yet been covered at the end of each bi-weekly reporting cycle. A sharp rise in the metric indicates that market participants are actively placing short bets against a given stock in anticipation that its value will decline rapidly in the foreseeable future. Conversely, a sharp decline in the metric indicates that short traders are closing their short positions as they perceive the stock to be fairly priced, with limited downside potential. Thus, the measure of short-term interest is a handy tool for gauging the street’s ever-changing sentiment regarding a given stock.

As for Alibaba, its short interest stood at 59 million at the end of the last reporting cycle ending September 30. This figure is up 7.2% sequentially and 47% in the last 5 months alone, indicating that market participants have gradually piled up their short bets against the company in recent months.

This accumulation of short interest is rather counter-intuitive as the stock has fallen continuously and should have, in theory at least, encouraged short market participants to close their short positions and take profits. But the fact that short-term interest in Alibaba continues to rise, despite its share price falling, suggests that market participants perceive the stock to be overvalued at current levels and are betting on further declines. action in the future.

Alibaba's share price over the last short interest cycle

BusinessQuant.com

Next, I wanted to compare Alibaba with other US-listed e-commerce stocks to get a better understanding of short-selling activity in said industry. If the market is betting against the vast majority of these stocks, Alibaba will not appear as the odd one out. But that’s not quite the case here. It turns out that short-term interest in Alibaba has grown much faster than a wide range of 30 other US-listed stocks that are engaged in e-commerce ventures. This confirms that market participants are more or less neutral on the industry but specifically bearish on Alibaba.

Short interest in the internet retail industry

BusinessQuant.com

This now raises an important question: why are market participants actively selling Alibaba when its shares have fallen significantly and are apparently undervalued?

Reasons fueling pessimism

First, I would like to dispel the misconception that Alibaba is undervalued after its recent correction. It may look undervalued on a stand-alone basis, but that’s not really the case when we look at industry comparables. The chart below should put things into perspective.

Alibaba's relative valuation

BusinessQiant.com

The Y-axis plots Enterprise Value vs. Free Cash Flow (or EV/FCF) values ​​for over 30 stocks ranked in the e-commerce/internet retail industry. Note how Alibaba is vertically positioned much higher than a wide swath of its mentioned peers, indicating the stock is trading at a relative premium.

Now let’s move on to the x-axis, which plots free cash flow growth for the same set of businesses. Note how Alibaba is horizontally positioned more or less in the middle, indicating that its free cash flow growth is in line with industry averages.

The collective conclusion from both axes here is that Alibaba is a poor performer in terms of free cash flow growth, but its shares are nonetheless trading at a premium. There are actually 4 other stocks in the e-commerce industry that are growing their free cash flow at a faster rate than Alibaba, but their stocks are still trading at a lower EV/FCF multiple.

It’s also not as if the business outlook is improving or signaling impending growth for Alibaba. Much like the United States, analysts and rating agencies have cut GDP growth forecasts for China almost every two weeks. This deteriorating macroeconomic environment is bound to limit personal disposable income and hamper consumer spending in major economies, which will inevitably weigh on Alibaba’s business. We are already seeing analysts cut their earnings estimates for the company and I suspect further cuts will follow at least in the next 2-3 months.

Chart
Data by YCharts

Compounding the problem is that we don’t know how much Alibaba’s revenue forecast will drop. Maybe 2 months later we would have reduced our revenue estimates for Alibaba by $10 billion or maybe it would be $30 billion, we just don’t know. This heightened uncertainty amid growing recession fears makes it difficult for anyone to call a bottom for an e-commerce company such as Alibaba. So that’s another major reason why we think we’re seeing a short spike in interest in the company’s stock lately.

Alibaba's Revenue by Segment

BusinessQuant.com

There is another variable at play here. US auditors visited Hong Kong a few weeks ago to carry out audit inspections on US-listed Chinese companies such as Alibaba. These inspections are expected to last 8-12 weeks and will reveal if Alibaba is audited under US GAAP or if there are any irregularities in its reports. If it is the latter, it will further fuel fear, uncertainty and doubt about the legitimacy of Alibaba’s growth prospects, and fuel speculation about the amount of sanctions that may be imposed by US regulators. This essentially means that the moment of truth is fast approaching for US-listed Chinese companies such as Alibaba.

(Lily – Alibaba: the SEC is moving)

Final Thoughts

The takeaway here is that Alibaba shares are trading at a premium to its peers, despite heightened macroeconomic and regulatory uncertainty surrounding the name. This is probably why the short interest in the name has increased and will also continue to do so in the coming weeks. So I think investors may want to avoid the stock for now, as it looks set to drop further from current levels. Good luck!

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