Why I Think Dangdang Will Trade Over $750/Share In 5 Years

Apr. 3.12 | About: E-Commerce China (DANG)

It is not a coincidence that action has picked up in Dangdang (DANG) stock the past month. Its fourth-quarter revenue grew 73% year over year and FY 2011 revenue grew 59%. Their general merchandise revenue was 76 million USD for the quarter and up 210% year over year. It gained 6.6 million new customers in 2011, bringing total active customers to 12.2 million. It grew active customers by 100 percent in 2011! I expect Dangdang to grow customers by 100 percent or more for years to come. The population of China is 1.4 billion and most in China don't even know what ecommerce is yet. In a prior article on Seeking Alpha, an author made a case for Dangdang sales to be 15 billion USD five years from now.

On March 29, Dangdang announced an alliance with Gome online to launch a marketplace to sell electronics and computer products. Electronics was a niche Dangdang did not offer before, so this will only compound its remarkable revenue growth.

What some see as a negative for Dangdang is its low profit margins. In order to increase revenue, it is slashing product prices, offering products at deep discounts. Dangdang's margins for the quarter were 10.5% compared with 13.8% last year. The low margins are okay to me, because if it continues to increase sales its bottom line will still be huge, and any improvement on margins will be gravy. In my opinion I think it will improve margins as it continues to enhance the technology of its fulfillment centers.

Here is how I am getting to a stock price on Dangdang of $750 or more five years from now. If the company is able to generate 15 billion in revenue, and its margins are between 10%-15%. Take the average of that -- 12% margins. 15 billion times 12% is 1.8 billion. I am calculating 1.8 billion EBITA. The company has 79.3 million shares outstanding. Take out for Interest, taxes and other expenses of say 300 million (NYSEARCA:USD), which leaves 1.5 million (USD) in earnings. 1.5 billion over 79.3 million shares outstanding is $18.91USD eps/ share. Amazon (NASDAQ:AMZN) , which is the Dangdang equivalent in the U.S. trades at a forward PE of 77. If I discount that for Dangdang being a Chinese company to say a PE of 40, that gives it a price valuation of $756.

My disclaimer is to keep in mind Dangdang is a Chinese ADR, and some Chinese ADRs have had a history of fraud. All of my numbers are in USD.

Disclosure: I am long DANG.