Dangdang Sell-Off Is Overdone; Q3 Not That Bad

| About: E-Commerce China (DANG)
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Summary

Stock down nearly 20% since Q3.

Sell-off is overdone; it's trading away from fundamentals.

Stock looks attractive at these levels.

E-commerce China Dangdang (DANG, profile) released Q3 earnings early last week and the stock has since made a nearly uninterrupted one-way move lower, shedding about 18% since the pre-earnings close of $12.41 on November 24.

As a quick recap of Q3 (more detail here), the company delivered revenue growth just above what the street was looking for, but missed earnings. Management's outlook may have been softer than investors had hoped; it included cooler revenue growth YoY and a slowdown in marketplace GMV growth vs. earlier quarters. Although delivering YoY increases in revenue of just under 30% may seem strong, it would be relatively slower than competitors JD.com (NASDAQ:JD), who guided a +62% YoY pace, and the consensus for Alibaba (NYSE:BABA) implies similar heady annual growth. The combination of an earnings miss and softer than expected guidance may be one of the reasons investors are selling, but is the sell-off overdone?

We think so, due to the progress that management is making in its transformative process to change Dangdang from 'a bookseller who sells other things too' to a more comprehensive online retailer.

On balance, Q3 wasn't bad, and not nearly as bad as the stock's fall would suggest. Investors are rightfully hungry for growing the business, but it wasn't too many quarters ago that the market was lamenting net losses. How quickly the dialog has changed. It may be helpful to note that the company hasn't been profitable on an annual basis since FY2010, and hadn't been profitable on a quarterly basis since FY2011.

Incidentally, the stock is pushing near the $10 per share mark, where it was trading before the company reported a profit in Q4 FY2013 (kicking off four straight quarters of delivering net income).

So if the stock was mispriced in early FY2014 (before the profitability surprise broke and it short up to over $19), what about now? Management is making solid progress scaling up the business (adding new customers, +3.6 million in Q3, up 24% YoY) and improving operating efficiency (fulfillment expenses per order steadily declining), which both long-term positives. Arguably, there is more clarity surrounding the company's prospects now than a year ago. Significantly more clarity.

Skeptics may note that the results of some of the company's recent initiatives have yet to show up in the P&L; net margins are relatively low and have been boosted by non-operating income and tax loss carryovers. This is true, however looking more closely at the income statement shows steady gross margin improvement YoY and stable operating margins. These are both positive trends, however margin expansion would be even more so.

Why has operating profit been stubbornly flat? Management has been investing in areas that could bring more future benefits, such as Technology and content and Marketing. Potential benefits from technology are obvious: improved efficiency (order fulfillment) and stronger sales and customer service channels (i.e. mobile). Spending on marketing is also relatively straightforward: customer acquisition. Granted, both may be somewhat speculative from an investor's point of view because the payoffs are uncertain, but judging from management's successes thus far, the probabilities may be tipped in Dangdang's favor.

What about the stock?

Dangdang is trading on a forward P/E of about 19x ($10.15 per share, $0.53 FY2015 consensus EPS), which is significantly lower than the north of 25x range it was trading in a month ago. Other ecommerce names trade significantly higher [JMEI is about 22x, JD is in four digits, BABA is about 36x, Amazon (NASDAQ:AMZN) is in triple digits; these aren't direct comps but provided for reference].

Progress the company has achieved thus far speak to management's ability to drive change while maintaining competitiveness. Dangdang's management is by no means done with the company's evolution. Although some investors may think Q3 was light, taking a longer-term view of the company while considering fundamentals makes the recent pullback a buying opportunity.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.