Alibaba Cloud's Growth Has Yet to Peak, While Improving Profitability and a Full-Stack AI Strategy Support Nomura's Reiterated Buy Rating

Overview

This report reviews Alibaba's June-quarter results, focusing on Alibaba Cloud, AI chips, Qwen applications, ecommerce businesses, and AI capital expenditure. Nomura believes quarterly earnings were affected by taxes and AI investment, but management's disclosures regarding cloud growth, margin improvement, and signs that AI business losses have peaked provide greater clarity on the company's AI commercial prospects. It therefore reiterates its Buy rating and USD178 target price.

Core views

Revenue and adjusted EBITA for the June quarter were broadly in line with market expectations, but non-GAAP net profit fell below the Bloomberg consensus, mainly because taxes increased 44% YoY. Nomura believes that weak quarterly profit was not the key takeaway from the results; more importantly, management provided a more positive and explicit outlook for AI and cloud operations. Meanwhile, mature businesses such as ecommerce increasingly resemble stable sources of earnings and cash flow. Management expects the profitability of most non-AI businesses to remain stable or improve. The report's most important incremental conclusion is that Alibaba Cloud's growth has yet to peak. External cloud revenue grew 45% YoY in the June quarter, marking its ninth consecutive quarter of acceleration. Management expects growth to exceed 50% in the September quarter and accelerate further in the December and following March quarters. As of August, MaaS annual recurring revenue had exceeded RMB 160 hundred million and remained on track to surpass RMB 300 hundred million by fiscal year-end. Based on this, Nomura believes AI demand is gradually transforming Alibaba Cloud from an investment-intensive growth business into a more important revenue and profit engine. The acceleration in cloud revenue has not come at the expense of margins. Alibaba Cloud's adjusted EBITA margin reached 11.6% in the June quarter, compared with approximately 7% a year earlier. Management expects further improvement over the coming quarters toward its long-term target of approximately 20%. Drivers include rapid revenue growth, improved resource utilization and pricing, a rising contribution from high-margin MaaS revenue, and greater adoption of internally developed T-Head chips. Simultaneous improvements in revenue and margins are a key reason behind Nomura's more positive outlook for the cloud business. Alibaba also provided additional disclosure on its T-Head semiconductor business for the first time. Its products span GPUs, CPUs, memory, and networking chips, allowing the company to optimize computing, storage, and networking at the system level rather than relying entirely on third-party hardware. Cumulative shipments of previous generations of T-Head AI chips have exceeded 500,000 units. The latest generation of domestically produced chips began deployment on Alibaba Cloud in August in supernode form. Management also expects the next generation of domestically produced AI chips to begin tape-out and initial production in the second half of 2026, targeting large-model training and inference. Alibaba believes T-Head is one of the few domestic AI chip designers capable of commercially supporting both large-scale training and inference workloads. The newly established AI Labs and Applications (ALA) combines disclosures for the Qwen large-model business with other traditional and emerging AI applications. The segment recorded an adjusted EBITA loss of RMB 139 hundred million in the June quarter, reflecting the company's large-scale investment in foundation models and Qwen applications. Management expects this to be the peak loss for the current fiscal year, with the loss narrowing to the low RMB 100 hundred million range in the September quarter and then remaining broadly stable or continuing to improve. Model training accounted for less than half of the segment's loss, with the remainder mainly arising from inference, marketing, and operating costs for Qwen applications. Management believes continued improvements in training efficiency will allow the company to increase training and enhance model capabilities without a proportional increase in losses. Nomura believes the guidance that losses have peaked significantly reduces downside risk to overall earnings, although ALA remains the largest near-term drag on profits. The ecommerce business remained relatively resilient despite weak consumer spending. Alibaba Ecommerce Group, which includes China ecommerce, China quick commerce, and international ecommerce, recorded adjusted EBITA of RMB 397 hundred million in the June quarter, broadly stable YoY. China ecommerce customer management revenue declined 7% YoY on a reported basis but grew 1% YoY on a like-for-like basis, broadly in line with market expectations. Management said China ecommerce performance in the September quarter to date had improved slightly from the previous quarter. Unit economics in quick commerce are also improving. Management expects the September-quarter loss to remain flat or decline QoQ, with the full-year loss narrowing by approximately 50% YoY, while maintaining its FY29E profitability target. Nomura therefore concludes that mature ecommerce businesses can sustain relatively stable earnings and cash generation, supporting investment in cloud and AI applications. The report considers AI capital expenditure and free cash flow to remain the greatest financial concerns. Capital expenditure reached RMB 677 hundred million in the June quarter, up significantly from RMB 269 hundred million in the previous quarter and equivalent to approximately USD10bn. Free cash flow recorded an outflow of RMB 447 hundred million during the same period. Management explicitly cautioned against simply annualizing the quarter's capital expenditure because hardware procurement and delivery schedules create quarter-to-quarter volatility. The company is willing to tolerate negative near-term free cash flow to maximize AI growth. Management remains relatively confident in the returns from intensive AI investment, stating that newly added AI infrastructure generally pays back within three years. Improving AI product margins, greater use of internally developed T-Head chips, customer prepayments, and alternative computing-capacity arrangements could further enhance capital efficiency. Nomura therefore views near-term negative free cash flow as the cost of expanding AI capabilities while emphasizing that returns on incremental infrastructure remain attractive. From a longer-term value-chain perspective, management believes AI commercial value will shift across layers. Hardware suppliers and infrastructure providers currently capture a larger share of value, but foundation models may ultimately create substantial value through business models that extend far beyond current API usage. Nomura believes Alibaba's full-stack capabilities spanning chips, cloud infrastructure, foundation models, and applications position it to benefit from current AI infrastructure development while preserving opportunities to participate in future value creation at the model and application layers. Regarding valuation, Nomura reiterates its Buy rating and USD178 target price. Its SOTP valuation values China Ecommerce Group at USD89bn based on 5x FY27F P/E, Alibaba Cloud at USD270bn based on 7x FY28F P/S, and assigns a net valuation of USD40bn to non-core assets, including international ecommerce. The USD178 target price implies approximately 22x CY27F, equivalent to FY28F, P/E, versus the current 16x. The rating benchmark is the Nasdaq Composite Index, and the Buy rating expresses an expectation of outperformance against this benchmark over the next 12 months.

Analysis framework

Nomura first compares June-quarter revenue, adjusted EBITA, and non-GAAP net profit with market expectations, then shifts the analytical focus to management's forward guidance for Alibaba Cloud's growth, margins, MaaS revenue, and AI chips. The report subsequently breaks down ALA losses, ecommerce profitability, and quick-commerce unit economics to assess whether mature businesses can support AI investment. It then evaluates investment efficiency using capital expenditure, free cash flow, and the infrastructure payback period. Finally, the report explains the long-term commercial opportunity through AI value-chain migration and full-stack capabilities and determines the target price using a sum-of-the-parts approach.

Methodology notes

• Valuation MethodSOTP Segment Valuation

  Sum-of-the-Parts Valuation

  The report separately values China ecommerce, Alibaba Cloud, and non-core assets, then combines the values of each component to derive the USD178 target price. This method is suitable for companies whose businesses differ significantly in structure and growth characteristics.

• Valuation MethodP/E and PEG Valuation

  P/E Valuation

  The report values China ecommerce at 5x FY27F P/E and notes that the target price implies 22x CY27F, equivalent to FY28F, P/E, versus the current 16x.

• Valuation MethodPS valuation

  P/S Valuation

  The report values Alibaba Cloud at 7x FY28F P/S to reflect its rapid growth while it remains in a phase of improving profitability.

• Corporate Fundamentals and Financial FrameworkFree cash flow analysis

  Capital Expenditure and Free Cash Flow Return Analysis

  The report combines RMB 677 hundred million of capital expenditure and an RMB 447 hundred million free cash flow outflow with management's assessment that new AI infrastructure can pay back within three years to evaluate the near-term cash cost and capital efficiency of AI expansion.

• Industry Analysis FrameworkUpstream, Midstream, and Downstream Industry-Chain Transmission

  AI Value-Chain Profit Migration Analysis

  The report believes commercial value is currently more concentrated in the hardware and infrastructure layers but may shift toward foundation models and applications in the future, and uses this view to analyze the significance of Alibaba's full-stack AI strategy.

Asset mapping & comparison

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

• Alibaba Group (BABA.US)

  The report believes the company will benefit from accelerating Alibaba Cloud growth, improving cloud margins, and the migration of AI value from infrastructure toward models and applications.

  Strengths

  Relatively stable profitability from mature ecommerce businesses; Alibaba Cloud's external revenue has accelerated for nine consecutive quarters; full-stack AI capabilities spanning chips, cloud, foundation models, and applications; internally developed T-Head chips support system optimization and capital efficiency.

  Weaknesses

  ALA continues to record substantial losses, while AI expansion has increased capital expenditure and resulted in negative near-term free cash flow.

  Comparison

  The target price implies 22x CY27F, equivalent to FY28F, P/E, versus the current 16x; the rating benchmark is the Nasdaq Composite Index.

  Risks

  Expanded investment could cause margins to fall below expectations; regulatory risks in payments and internet finance could harm the core business and the value of Ant Group.

Key data

• Alibaba Cloud External Revenue Growth45% YoY growthJune quarter; accelerated for the ninth consecutive quarter
• Alibaba Cloud September-Quarter Growth GuidanceAbove 50%Management expects further acceleration in the December and following March quarters
• MaaS Annual Recurring RevenueOver RMB 160 hundred million as of AugustFiscal year-end target of more than RMB 300 hundred million
• Alibaba Cloud Adjusted EBITA Margin11.6%Approximately 7% a year earlier; long-term target of approximately 20%
• Cumulative Shipments of Previous Generations of T-Head AI ChipsOver 500,000 unitsThe latest generation of domestically produced chips began deployment on Alibaba Cloud in August in supernode form
• Next-Generation Domestic AI Chip Timeline2H26ETape-out and initial production are expected to begin, targeting large-model training and inference
• ALA Adjusted EBITA LossRMB 139 hundred millionJune quarter; management expects this to be the peak loss for the current fiscal year
• ALA September-Quarter Loss GuidanceLow RMB 100 hundred million rangeExpected to remain broadly stable or continue improving thereafter
• Ecommerce Group Adjusted EBITARMB 397 hundred millionJune quarter; broadly stable YoY
• China Ecommerce Customer Management RevenueDown 7% YoY on a reported basis; up 1% YoY on a like-for-like basisBroadly in line with market expectations
• Full-Year Quick-Commerce Loss GuidanceExpected to narrow by approximately 50% YoYFY29E profitability target maintained
• June-Quarter Capital ExpenditureRMB 677 hundred millionRMB 269 hundred million in the previous quarter; equivalent to approximately USD10bn
• June-Quarter Free Cash FlowOutflow of RMB 447 hundred millionThe primary financial concern stems from AI investment
• Payback Period for New AI InfrastructureGenerally less than three yearsManagement's assessment of returns on incremental investment
• Target PriceUSD178.00Unchanged; implies 22x CY27F, equivalent to FY28F, P/E, versus the current 16x
• China Ecommerce Segment ValuationUSD89bnBased on 5x FY27F P/E
• Alibaba Cloud Segment ValuationUSD270bnBased on 7x FY28F P/S
• Net Valuation of Non-Core AssetsUSD40bnIncluding the international ecommerce business

Impact & implications

Nomura believes Alibaba's earnings structure is changing: mature ecommerce businesses continue to provide stable earnings and cash flow, while Alibaba Cloud is becoming a more important growth and profit engine as revenue accelerates and margins expand. ALA remains a drag on near-term earnings, and AI capital expenditure will also weigh on free cash flow. However, peaking losses, an infrastructure payback period of less than three years, and the adoption of internally developed chips improve the visibility of investment returns. Full-stack AI capabilities enable the company to participate in current infrastructure development while retaining exposure to future value growth in foundation models and applications.

Risks

• Accelerated AI and other investments could cause margins to fall below expectations.
• Regulatory risks in the payments and internet finance industries could affect Alibaba's core business and the value of its stake in Ant Group.
• Large-scale AI capital expenditure could continue to result in negative near-term free cash flow.

What to watch

• Monitor whether Alibaba Cloud's revenue growth can exceed 50% in the September quarter and accelerate further in the December and following March quarters.
• Monitor whether MaaS annual recurring revenue can increase from more than RMB 160 hundred million as of August to more than RMB 300 hundred million by fiscal year-end.
• Monitor whether Alibaba Cloud's adjusted EBITA margin can continue improving toward its long-term target of approximately 20%.
• Monitor whether ALA's loss declines from its June-quarter peak of RMB 139 hundred million to the low RMB 100 hundred million range in the September quarter.
• Monitor deployment of the latest domestically produced T-Head chips and whether the next generation can begin tape-out and initial production in the second half of 2026.
• Monitor whether the full-year quick-commerce loss can narrow by approximately 50% YoY while remaining on track for FY29E profitability.
• Monitor quarterly fluctuations in capital expenditure, changes in free cash flow, and whether new AI infrastructure can achieve payback within three years.