Alibaba (NYSE:BABA) stock continues to sink after the company reported disappointing earnings in its Q2, and many investors have thrown in the towel on fears that what was once one of the preeminent Chinese internet stocks is damaged goods forever.
- Recent earning miss exacerbated the drop
- Company faces macro and geopolitical risk
- But is highly undervalued relative to peers
- Defined risk strategy may be the best way to trade it
The negatives against BABA are well known and should not be taken lightly. The company not only faces economic headwinds, but political pressure as well as it continues to feel the heat from regulators. In 2021, BABA was forced to pay a $2.8-billion fine, which negatively impacted earnings and, more importantly, remains vulnerable to further regulatory oversight as the Chinese authorities continue to exert more control over its affairs, especially the financial unit ANT, which was forced to cancel its IPO.
On the economic front, China is clearly experiencing a stealth recession as the stringent new regulations on ownership of real estate for investment purposes and the seeming default of the country’s biggest real estate developer Evergrande Holdings has severely curtailed the credit impulse, with some analysts suggesting that China may be experiencing its own version of the 2007 credit crisis.
Furthermore, the geopolitical conflict in the region remains inflamed as tension with Taiwan continues to escalate. Some market watchers expect Chinese military incursions into Taiwan air space to increase after the Beijing Winter Olympics. If that, indeed, turns to be true, the Chinese equity market could see a massive risk aversion move that would likely push BABA below 100.
So the risks are real and should not be minimized, yet the underlying operating business of BABA remains sound. The company has now pushed above the 1-billion customer mark and sales continue to expand at high double-digit rates. Furthermore, the company’s heavy investment into the cloud should begin to pay off as China quickly moves into the Internet of Things mode, with almost every device connected to some sort of surveillance mechanism allowing for a much more productive real-time framework to coordinate economic activity.
Meanwhile, BABA’s valuation is a fraction of its global peers, presenting an opportunity for value-oriented investors to establish a position at highly discounted rates. Still, the swirl of macro and geopolitical risks makes investing in the underlying stock a very risky proposition. Investors would be better served in a defined risk trade like buying the December 2022 120/150 call vertical currently trading at 10 and would pay out 30 if the stock rises above 150 by the end of 2022.