Alibaba’s Quarterly Profit Is Set to Plummet 60%. Here’s Why.

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Alibaba

‘s quarterly profit is expected to fall almost 60% year over year when the Chinese tech giant reports earnings on Thursday. Investors shouldn’t worry too much — it’s not as bad as it might seem on the surface.

Alibaba (ticker: BABA) is expected to report net income of $5.1 billion for the final three months of 2021, based on the estimates of analysts surveyed by FactSet. Profit in that range would compare to $12.3 billion reaped by the e-commerce and cloud computing powerhouse in the same quarter in the year prior year, marking a fall of more than 58%.

It can be explained.

The decline in profit looks less bad using Alibaba’s preferred adjusted metric, which is also the earnings figure most closely watched by analysts.

Alibaba is expected to report earnings before interest, taxes, depreciation, and amortization (Ebitda) of $8.1 billion for the quarter, which would be only 23% less than the Ebitda of $10.6 billion at the end of 2020.

Still, that’s a hefty drop. What’s behind it?

“It is the consequence of slowing revenue growth and accelerating spending,” Danny Law, an analyst at Guotai Junan Securities — one of China’s biggest investment banks — told Barron’s.

Also read: Alibaba Earnings Are Coming. 4 Numbers to Watch.

Let’s break it down.

Law and his team see most Chinese companies facing a slowdown to their top line or revenue for four key reasons.

The first is a weak macroeconomic outlook in China. Both government and private-sector data indicate that Chinese consumers have had a tough time, with retail sales and online consumption slowing into the end of 2021. China’s economy and restrictions linked to the Omicron surge of Covid-19 cases share the blame. 

The second is a highly competitive environment as the sector faces anti-monopoly regulations. The Chinese tech sector was battered in 2021 from a regulatory crackdown by Beijing, which helped Alibaba lose almost 50% of its market value last year. Analysts tend to believe the worst is over, though the past week has brought some signs that regulators continue to keep a watchful eye on developments in the sector generally and on Alibaba and its affiliates in particular.

The third reason cited by Law are decisions by Alibaba and others in e-commerce to waive fees for merchants to increase retention on their platforms. This would represent a strategic choice to pinch short-term revenue in favor of longer-term stability.

The fourth factor behind what looks, on the surface, like a stunning fall in profit is due to what is known as the base effect. Year-over-year growth is closely watched by investors when companies report earnings. But this number can be distorted when the year being compared to is abnormal. And 2020 was abnormal; e-commerce groups in particular boomed as millions of people housebound by the Covid-19 pandemic shopped online. While Alibaba’s earnings at the end of 2021 are likely to be sharply lower than in 2020, it should still have been one of its most profitable quarters ever.

These four factors identified by Law form a core part of why Alibaba is likely to report lower sales for its most recent quarter. Less revenue tends to also mean less profits, but there are other factors dragging on earnings themselves.

In this case, higher spending is likely to dig into the bottom line. It’s not a bad thing.

“We think it is reasonable for China’s tech sector to increase spending in research and development, sales and marketing, and admin expenses, edging up their competitive advantages,” Law said. “It should be the new normal under the anti-monopoly practices.”

Alibaba began to show flagging revenue growth when it last reported earnings; profits were also sharply lower year over year in the last quarter. The picture, fundamentally, hasn’t changed much. But that doesn’t mean the stock won’t be volatile on Thursday. 

Earnings surprises of more than 10% above or below analysts’ expectations for Alibaba’s performance are not unusual. However, earnings in the last four December quarters have been, on average, 4.25% higher than analysts’ estimates.

Alibaba shareholders have been taken on a wild — and mostly ugly — ride over the past year. If anything can be expected from the reaction to earnings, it’s more of the same volatility.

Write to Jack Denton at [email protected]