Alibaba Cloud growth continues to accelerate, while guidance for narrowing AI Labs losses could ease pressure on group earnings

Overview

The report reviews Alibaba's Q1 FY3/27 results and latest segment realignment. The overall quarterly results contained few surprises, while e-commerce monetization revenue and group profit remained under pressure, but cloud computing and AI-related revenue accelerated significantly. The company also guided for continued acceleration in its cloud business, margin expansion and narrowing AI Labs losses. Bernstein therefore maintains a positive view and derives target prices of US$180 for BABA and HK$176 for 9988.HK using an SOTP valuation of the core e-commerce and cloud businesses.

Core views

First, Alibaba has again revised its segment disclosures, which the report believes is reshaping the company's AI narrative. The e-commerce businesses have been consolidated into Alibaba E-commerce Group, which now includes Freshippo; T-head has been moved into AI Cloud; and Qwen and related applications have been placed in the newly established AI Labs and Applications segment. The e-commerce restructuring makes the business presentation more stable, while separately disclosing computing infrastructure and application-layer AI allows investors to observe more clearly the changes in revenue and losses across cloud computing, chips, models and applications. It also explains part of the previous increase in All Others losses. At the group level, Q1 FY3/27 results were broadly in line with expectations. Revenue for the June quarter was RMB 2689.53 hundred million, up 8.6% year over year, 0.4% below Bernstein's forecast and 0.2% above market consensus. Adjusted EBITA was RMB 273.29 hundred million, representing a margin of 10.2% and a year-over-year decline of approximately 30%, but it was 2.6% and 2.8% above Bernstein's forecast and consensus, respectively. The year-over-year profit decline primarily reflected continued investment in quick commerce and losses now separately allocated to AI Labs and All Others. However, losses caused by quick-commerce investment are narrowing quarter over quarter. Growth and monetization in the e-commerce business remained weak. Alibaba E-commerce Group revenue was RMB 2058.62 hundred million, up 3.5% year over year, while adjusted EBITA was RMB 397.49 hundred million, with a margin of 19.3% and profit broadly flat year over year. Customer management and commission revenue was RMB 825.47 hundred million, down 7.5% year over year; excluding the accounting change that treats marketing expenses as a reduction of revenue, it increased by approximately 1% year over year. China e-commerce revenue declined 8.3% year over year, while direct sales, logistics and other revenue declined 10.5%. Meanwhile, China quick-commerce revenue reached RMB 532.95 hundred million, up 45.1% year over year, indicating that the high-growth business is still pursuing expansion through substantial investment. AI Cloud is the report's most important positive indicator. Segment revenue was RMB 484.37 hundred million, up 44.9% year over year, 0.8% below Bernstein's forecast and 2.0% above consensus; external revenue grew at a similar rate. External AI cloud revenue reached RMB 124 hundred million in the quarter, up 37.5% from RMB 90 hundred million in Q4. As of August, MaaS annual recurring revenue exceeded RMB 160 hundred million, which the report believes may have been supported by the recent rapid development of open-source models. The company guided for Alibaba Cloud revenue growth above 50% over the next several quarters, implying that the current acceleration is not limited to this quarter. Cloud profitability is also improving. AI Cloud adjusted EBITA was RMB 56.28 hundred million, corresponding to a margin of 11.6%, 4.4% below Bernstein's forecast but 9.4% above consensus. The chart shows an adjusted EBITA incremental margin of 21%. If Alibaba's year-over-year increase in depreciation costs is allocated to AI Cloud, the report estimates that the previous quarter's incremental EBITDA margin was 51.2%. The company also expects cloud margins to continue expanding over the next several quarters and believes that cheaper in-house chips can gradually reduce computing costs. If shipments of T-head's Zhenwu chips continue to ramp up, they will also contribute to revenue and margins. To support the expansion of AI infrastructure, Alibaba's Q1 capital expenditure reached RMB 677 hundred million, a significant increase from previous quarters that echoed Tencent's sharp rise in capital expenditure during the same quarter. The company's discussions with Bernstein indicated that capital expenditure this quarter may have been above the normal trend, but the high investment is expected to help cloud revenue accelerate further. Management stated that the breakeven period for capital expenditure is currently approximately 3 years and may shorten to 2 to 2.5 years in the future. Bernstein's cash flow forecasts show capital expenditure of RMB 2526.60 hundred million in FY3/27E and RMB 2800 hundred million in both FY3/28E and FY3/29E, indicating that the model continues to assume sustained high investment in AI infrastructure. Application-layer AI currently remains a major drag on group profit. AI Labs and Applications revenue was RMB 33.38 hundred million, up 15.8% year over year, with growth primarily coming from existing software such as DingTalk and Quark rather than being driven entirely by new AI applications. The segment recorded an adjusted EBITA loss of RMB 138.61 hundred million, representing a margin of -415.2%. The report believes future revenue growth can serve as an important indicator for monitoring the commercialization progress of Qwen Work. More importantly for group earnings forecasts, the company explicitly guided that AI Labs losses will narrow over the next several quarters. Over the longer term, part of the post-training costs for popular models will be borne by AI Cloud, so the reduction in application-layer losses must still be assessed together with cloud margins. Bernstein ultimately rates Alibaba Outperform. Its target prices are US$180 per share for BABA and HK$176 per share for 9988.HK, with BABA offering 40% upside relative to the US$128.90 closing price stated in the report. The valuation uses an SOTP methodology, separately valuing and then aggregating the core e-commerce and cloud businesses based on their revenue and profit over the next year. The report's positive view is not based on group profit this quarter, but on the combination of accelerating cloud revenue, expanding cloud margins, lower costs from in-house chips and the gradual narrowing of AI Labs losses. Meanwhile, weak e-commerce monetization, quick-commerce investment and high capital expenditure remain factors that must be continuously balanced as earnings improve.

Analysis framework

The report first compares the quarterly results with Bernstein's forecasts and market consensus, then breaks down revenue and adjusted EBITA across the reorganized e-commerce, AI Cloud, AI Labs and other businesses. It subsequently assesses the cloud business's growth and return trajectory through external AI cloud revenue, MaaS annual recurring revenue, capital expenditure, incremental margins and management guidance, while analyzing the impact of narrowing AI Labs losses on group profit. Finally, it applies an SOTP valuation based on the core e-commerce and cloud businesses' revenue and profit over the next year.

Methodology notes

• Valuation MethodSOTP Segment Valuation

  Aggregate valuation of the core e-commerce and cloud business segments

  Bernstein separately values the core e-commerce and cloud businesses based on their revenue and profit over the next year, then aggregates the value of each part to derive target prices of US$180 for BABA and HK$176 for 9988.HK.

• Event-Driven Trading and Behavioral FinanceExpectation Gap/Expectation Management

  Comparison of actual results with institutional forecasts, market consensus and company guidance

  The report compares actual revenue and EBITA with Bernstein's forecasts and consensus expectations, and uses guidance for cloud growth, margins and AI Labs losses over the next several quarters as the basis for assessing changes in expectations.

• Company Fundamentals and Financial FrameworkEarnings Quality Analysis

  Analysis of adjusted EBITA, incremental EBITDA margins and capital payback periods

  The report examines not only revenue growth but also the cloud business's adjusted EBITA margin, the impact of depreciation, incremental EBITDA margins and the capital expenditure breakeven period to determine whether growth can translate into higher profit.

• (Method Outside the Vocabulary)

  Breakdown of segment revenue and EBITA following the restructuring

  The report separates e-commerce, AI Cloud, AI Labs and All Others under the new disclosure framework to distinguish the respective sources of growth, costs and losses between infrastructure-layer AI and application-layer AI.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• Alibaba Group (BABA, 9988.HK)

  The core equity asset covered by the report; accelerating cloud computing growth and narrowing AI Labs losses are positive drivers, while pressure on e-commerce monetization and high investment weigh on near-term group profit.

  Strengths

  AI Cloud revenue increased 44.9% year over year, while external AI cloud revenue increased 37.5% quarter over quarter; the company guided for cloud growth above 50% and margin expansion over the next several quarters, while in-house chips may also reduce long-term costs.

  Weaknesses

  Group adjusted EBITA declined approximately 30% year over year, customer management and commission revenue declined 7.5% year over year, and AI Labs recorded a quarterly adjusted EBITA loss of RMB 138.61 hundred million.

  Comparison

  Group revenue was close to Bernstein's and market expectations, while group adjusted EBITA exceeded both; AI Cloud adjusted EBITA was 4.4% below Bernstein's forecast but 9.4% above consensus.

  Risks

  Macroeconomic conditions, platform user engagement, competition among internet platforms, regulatory changes including antitrust measures, and continued losses in innovative and other businesses.

Key data

• Q1 FY3/27 Group RevenueRMB 2689.53 hundred millionUp 8.6% year over year; 0.4% below Bernstein's forecast and 0.2% above consensus
• Q1 FY3/27 Group Adjusted EBITARMB 273.29 hundred millionDown approximately 30% year over year, with a margin of 10.2%; 2.6% and 2.8% above Bernstein's forecast and consensus, respectively
• Alibaba E-commerce Group RevenueRMB 2058.62 hundred millionUp 3.5% year over year
• E-commerce Group Adjusted EBITARMB 397.49 hundred millionMargin of 19.3%, broadly flat year over year
• Customer Management and Commission RevenueRMB 825.47 hundred millionDown 7.5% year over year; up approximately 1% excluding the change related to treating marketing expenses as a reduction of revenue
• China Quick Commerce RevenueRMB 532.95 hundred millionUp 45.1% year over year
• AI Cloud RevenueRMB 484.37 hundred millionUp 44.9% year over year; the company guided for growth above 50% over the next several quarters
• External AI Cloud RevenueRMB 124 hundred millionUp 37.5% from RMB 90 hundred million in Q4
• MaaS Annual Recurring Revenue in AugustMore than RMB 160 hundred millionThe report believes the development of open-source models may have provided support
• AI Cloud Adjusted EBITARMB 56.28 hundred millionMargin of 11.6%; 4.4% below Bernstein's forecast and 9.4% above consensus
• AI Cloud Incremental MarginAdjusted EBITA incremental margin of 21%; estimated incremental EBITDA margin of 51.2%The latter estimate is based on allocating the year-over-year increase in group depreciation costs to AI Cloud
• AI Labs and Applications RevenueRMB 33.38 hundred millionUp 15.8% year over year, mainly driven by existing software such as DingTalk and Quark
• AI Labs and Applications Adjusted EBITALoss of RMB 138.61 hundred millionMargin of -415.2%; the company guided for losses to narrow over the next several quarters
• Q1 Capital ExpenditureRMB 677 hundred millionIncreased significantly quarter over quarter, but the company believes the quarter may have been above the normal trend
• Capital Expenditure Breakeven PeriodApproximately 3 years, potentially declining to 2 to 2.5 years in the futureManagement's assessment of the return period for AI infrastructure investment
• Q1 Diluted Weighted Average SharesIncreased 1% year over yearChange in share count during the first quarter of FY3/27

Impact & implications

The report believes Alibaba's earnings drivers are shifting from sole reliance on e-commerce stability toward the combined impact of accelerating cloud computing, returns on AI infrastructure investment and narrowing application-layer losses. If cloud revenue growth exceeds 50%, margins continue to expand and AI Labs losses narrow as guided over the next several quarters, group earnings forecasts will receive support. However, weak e-commerce monetization, quick-commerce investment and high capital expenditure mean the improvement trajectory will still require substantial investment.

Risks

• Macroeconomic factors such as credit conditions and retail consumption may affect Alibaba's business and valuation.
• User engagement on Taobao, Tmall and other platforms may fluctuate.
• Competition from other internet platforms may weaken growth or profitability.
• Regulatory changes, including China's antitrust regulation, pose downside risks.
• Continued losses in innovative and other businesses may weigh on group profit.

What to watch

• Monitor whether Alibaba Cloud revenue growth can reach the company's guidance of above 50% over the next several quarters.
• Track cloud margin expansion and the impact of ramping Zhenwu chip shipments on costs.
• Monitor whether AI Labs losses narrow over the next several quarters in line with company guidance.
• Track AI Labs revenue growth to assess the commercialization progress of Qwen Work.
• Watch whether high capital expenditure can shorten the breakeven period from approximately 3 years to 2 to 2.5 years.