Market Mad House

In individuals, insanity is rare; but in groups, parties, nations and epochs, it is the rule. Friedrich Nietzsche

Market Commentary

Is Alibaba Holdings Making Money?

Alibaba Holdings (NYSE: BABA) is unusual as one of the few giant Chinese companies traded on an American stock exchange. It is also one of the fastest growing businesses in the world.

Growth at Alibaba has been extraordinary, its revenue rose from 158.273 billion yuan in 2017 to 250.266 yuan in 2018. That gave Alibaba revenues of $39.9 billion in 2018, according to Statista, small potatoes when compared with Walmart (NYSE: WMT) and Amazon (NASDAQ: AMZN) but huge.

Alibaba reported a net income of 65.093 billion yuan and a total cash flow of 125.17 billion yuan in on March 31, 2018. Yahoo Finance calculated that Alibaba’s cash and equivalents changed by 55.573 billion between 1st Quarter 2017 and 1st Quarter 2018.

Is the China Boom Sustainable?

All this gave Alibaba 199.309 billion yuan in cash and equivalents and total assets of 717.124 billion yuan on March 31, 2018. The company also faced total liabilities of 280.686 billion yuan.

Therefore, Alibaba is a cash rich company, and a fast growing. Basically, Alibaba is telling us something that we already knew. There is a lot of cash in China, and that cash is increasing.

Unfortunately, what Alibaba is not telling us is us if the new Chinese boom is sustainable. The billion dollar question is the expansion of China’s middle class a permanent and sustainable development.

Investing in China’s Middle Class

Alibaba’s customers are China’s middle class which is growing fast. The middle class has grown from around 3% of the population of the People’s Republic in 1999 to 25% of the population in 2013, Pew research estimated.

That middle class certainly has a lot of money, Chinse tourists spent $258 billion abroad in 2017, Stratfor estimated. That figure alone gives us some idea of the potential spending power that Alibaba can tap.

The Chinese middle class is expected to grow dramatically, by up to 850 million people by 2030, The Sydney Morning Herald pointed out. This would make 73% of China’s population middle class.

China would become a middle class consumer society like the United States, and Alibaba would be its retailers. That might account $10 trillion worth of consumption or 18% of the world’s gross domestic product (GDP). In contrast, US consumption would be around $4 trillion. Another study had it even higher stating that Chinese consumption might reach $14.3 trillion by 2030.

Such figures make the case for Alibaba as a growth and a value investment. China is becoming a middle class nation and Alibaba is its department store. Just as Sears was America’s department store in the 20th Century.

Upwardly mobile Chinese will buy the trappings of their middle class lifestyle from Alibaba. Just as upwardly mobile Americans religiously shopped at Sears in the 1960s and 1970s.

Is China’s Middle Class Sustainable?

Obviously, many questions remain including can China really support all those consumers.

Will the economy of the People’s Republic generate enough cash to sustain such a consumer economy? Is China’s economy really capable of supporting a middle class consumer economy and a welfare state?

Even the United States with all its resources is having a difficult time sustaining a middle class economy. The North American middle class is projected to shrink by around 15 million people by 2030. Since, China’s structural and political problems are greater than America’s it might have a harder time sustaining the middle class dream.

Would China be a second United States, or Argentina writ large? Argentina almost achieved middle class status, and nearly rivaled the United States as a rising economic powerhouse during the first two decades of the 20th Century. Today, it is an economic basket case subsisting on handouts from the International Monetary Fund.

China’s Wealth is Sustainable

History teaches that us that China’s wealth is sustainable, and can form the basis for a middle class society. Argentina never developed a middle-class society because its wealth was based on agriculture controlled by a tiny elite not manufacturing.

In contrast to Argentina, China is a manufacturing powerhouse. Argentina was merely a resource colony that never quite got the industrial revolution right.

Today Argentina; which was a resource colony of Britain for most of its history, is now a resource colony of China. History teaches that manufacturing pays and translates into military and economic power.

Yet history also teaches us that manufacturing powerhouses do not last. Britain and the United States each held and lost the title of “workshop of the world” before China took over.

The rapid decline of American manufacturing over the past 50 years should give China bulls pause. Yet, post-industrial America’s relative prosperity points to the sustained viability of a consumer economy.

The key difference between Argentina and the United States or China is that Argentina’s wealth was based upon agriculture. During the first three decades of the 20th Century Argentina became rich by producing beef, wheat, and other food stuffs for Europe. The height of Argentine wealth was World War I when the British Empire needed to feed the armies in the trenches.

After 1930, Argentine wealth declined rapidly along with the fortunes of Argentina’s main customer – the British Empire. By the 1950s, Argentina was an economic basket case and has remained so ever since. American and Chinese prosperity is probably more durable because it is based on creativity and technology not resources.

Alibaba is undervalued

My take is that Alibaba is undervalued given its incredible growth rate and unparalleled access to the fast-growing Chinese middle class. Those seeking a stock capable of a lot of growth should check out Alibaba.

This ecommerce giant will be quite capable of Amazon-type growth in the years ahead. Buying Alibaba now will help Americans cash in on the booming Chinese middle class. Even if the Chinese class boom busts, Alibaba will make a lot of money.

Understanding Alibaba can help you understand, the future of China and the world. All value investors need to pay close attention to Alibaba and study it closely to understand the future of the world’s economy.