Baozun Up 31%: The New Strategy Impresses

Summary

• Baozun released its Q4 and FY 2017 results pre-market on March 6th and the stock went through the roof: +31%.
• The results showed that the strategy that the management has been rolling out has great effects.
• There was probably a short squeeze too: the short interest had been rising and the previous earnings caused huge drops.
• The future of Baozun looks great: it is the gatekeeper for a secular growth trend.

Introduction

On March 6th, before the market opened, Baozun (NASDAQ:BZUN) released its earnings. Traditionally that has been a time of a big moves for the company's stock.

This is for example after the earnings release of Q2 2017:

BZUN data by YCharts

And this is after Q3 2017

BZUN data by YCharts

Maybe those big drops scare you, but I first introduced Baozun (BZUN) to my readers as a potential multi-bagger in May of 2017 in the article "Potential Multibaggers Pt.2: Baozun, the Chinese Shopify." Since then, the stock has gone up quite a bit, despite the big drops after Q2 and Q3 earnings:

BZUN data by YCharts

Now after the earnings that were released, there was another giant move, albeit this time up:

BZUN Price data by YCharts

A lot of investors will wonder if the ship has sailed or if there is still time to go in after such a rise: 150% over 10 months, more than 20% on a single day? In this article I will try to answer those questions, using the Q4 2017 and FY 2017 results. But first, for those who don't know the company yet: what is Baozun and what's its business?

Introduction to the company

(Source: baozun.com)

Baozun is a Chinese e-commerce service company that is involved in the whole process of e-commerce: software, online store development, store operations, digital marketing, customer services, warehousing and fulfillment (distribution). It operates on JD.com (JD) and even more on Tmall (BABA), but also on mobile social media malls, the official brand stores and even offline smart stores.

To put it simple, if a major Western brand wants to sell on the Chinese e-commerce market (and which brand wouldn't want that these days?), Baozun is the one-stop shop to do it. It can translate both language and concepts to the Chinese market, implement the clients' strategy, integrate all activities and make innovations if desirable. Because an image says sometimes more than a thousand words, here is one:

(Source: Baozun investor relations)

Baozun was founded in Shanghai in 2006, so it has more than a decade of experience and it is the biggest player in its market. The rest are smaller players, but Baozun has about 20% of its market. Although the company's offices are still mainly in China, it also reaches out to its clients by having offices in the USA, Japan, Korea and Taiwan.

Its Nasdaq IPO was in May 2015. This is its price evolution since then:

BZUN data by YCharts

As you can see, the company is up more than 360% over those almost three years, beating the S&P 500 by 330%. But along that ride there has been a lot of volatility, which is typical for high growth stocks.

The numbers of Q4 and FY 2017

On March 6th, before market, Boazun announced its results from Q4 and FY2017. The results were impressive, that is if you know how to interpret them. And that may not be so simple if you don't follow this stock. The company has been rolling out a new strategy, which I will come back to. That strategy is the explanation for some of the remarkable numbers in the results of Q4 and FY 2017.

The most important metric to look at in the results of Baozun is GMV. GMV stands for Gross Merchandise Volume, which indicates the total amount of sales of an online shop. For Baozun, the GMV increased by 76% year-over-year, which is even better than Q3, when it was already a whopping 71%.

While that is already a very big and important result, it also shows that the strategy of Baozun works. This is the traditional model of Baozun:

(Source: Baozun investor relations)

Baozun's strategy is focusing more and more on A and B (service fee and consignment) while C (the distribution model) is will be reduced. That means less investments in expensive ownership of the products, more in services. This is a clear cost-light model and the strategy, which was announced in Q2 2017, starts to show its benefits to investors.

If you know that, the results are even more impressive: Baozun essentially doubled its non-distribution GMV (92.6% YoY growth). Those are great numbers and these show what I already foreshadowed after Q2 2017 earnings. I was enthusiastic about this strategy, but the fickle Mr. Market didn't agree with me and Baozun went down by 25%. In my article that I wrote as a response to that drop and the Q2 earnings, I tried to convince my readers not to sell any share, but to accumulate. I ate my own pudding and did just that.

The A part of the graph is very important to me: I like subscription revenues, because they are predictable and recurring. You don't have to convince the same customer again and again. If he likes your model, he will keep his subscription.

Because of this new focus on asset-light markets, Baozun's revenue is not as important as for other companies while they make the transition. The distribution model has very thin margins, but huge revenues, while the non-distribution model has higher margins and lower revenue numbers. So while it may sound strange, I'm happy that Baozun's revenue wasn't up that much: 93% non-distribution GMV growth versus only 23% revenue growth. This was even a miss by almost 2%. For a lot of companies, this would cause a drop, for Baozun, it's actually good news.

The change in focus of business model was also very clear in the GAAP operating margins. Those were 11.2% now versus 4.9% last year. That shows why I am thrilled by this new approach: there is simply more profit in it.

Another important aspect is the number of brands that Baozun was able to add. It has 152 brand partners now. That is 19 more than last year and 6 up QoQ. That may not seem spectacular to those who don't follow Baozun, but this is a very solid pace if you know that the customers Baozun focuses on are the first tier customers: Microsoft (MSFT), Nike (NKE), Starbucks (SBUX), Calvin Klein, Zara, Huawei, Samsung (OTCPK:SSNLF), Shell (RDS.A) (RDS.B), Honda (HMC), Burger King, NBA etc.

The huge rise on March 6th: more than great results

After the earnings release, Baozun went up by more than 30% on a single day. Of course the earnings were great and they show that the new focus works perfectly. And yes, the prospects for Baozun are great. For the next quarter the YoY service growth is expected to be over 50% again. Baozun is still relatively small too: even after this huge surge, the company only has a market cap of $2.5B. That indicates that there it a lot of room left for growth.

But I think that there is more needed to explain this giant step upwards then just these elements. A few readers had already pointed out to me that the short interest in Baozun had been rising steadily. From the last data that are available, there was a 13.5% short interest. The shorters needed about 4 days to cover their position. But I think that the short ratio had gone up substantially before earnings. Don't forget that the last two times the stock went down by 20% to 25% after earnings. I think a lot of shorters have taken a bet before earnings that the same scenario would unfold again. As the good earnings came in, the stock was up about 2% in the beginning pre-market. Because of the big beat by 11 cents, 26% above estimate consensus, because of the relatively high short ratio and because of the upward movement after earnings, I think we have witnessed a short squeeze from the book.

The future

There is a lot to like in Baozun and I won't sell a single share. I will keep adding to my position, even after these huge gains. Mostly winners keep on winning. I will hold my shares for the very long term, which means a few decades in my book. That is because I think that there are plenty of opportunities left.

The company has a great technology platform and therefore it can adapt its 'technology as the market environment changes', as CEO and founder Vincent Qiu told on the CC. He added:

We plan to continue investing in technology to further strengthen our leadership position and expand the array of services we are able to offer in order to create greater value for our shareholders.

As I have already pointed out in my previous articles about Baozun, the company still has a huge market left in the lower tiers of customers, the middle and small caps. And they could even venture into the world of the small business owners, just as Shopify (SHOP) has done. But this will probably not be for the first years or even decade, since there are simply too much opportunities left to seize for Baozun in its core market. It is only starting to tap its size advantage. Don't forget that software companies, which Baozun is to a great extent, have a lot of costs in the beginning to develop their software, but once that software is developed they don't have big extra costs when they add more and more customers.

Baozun also has the future because it is in the right country. Retail sales are growing at high speed in China, but e-commerce sales even much more. To put this into numbers: 7.2% retail growth in 2017 in China, but 32.1% for e-commerce sales. That is enormous, especially if you compare this to the US: the e-commerce sales growth is about 10%. And since 2012 it has not been higher than 14%. PwC therefore calls China a 'must-play, must-win market for retailers and brands globally.' And Baozun is the biggest player in its market: bringing Western brands to the Chinese market.

Conclusion

Baozun's strategy has worked out well and the results were clearly visible in this great quarter. But even after this huge surge, the company remains attractive for the long term, because of the secular trend to more and more brands will want to fully tap the Chinese e-commerce market.

I don't know what the stock is going to do the next days or weeks. Will it drop as spectacularly as it has surged today? Maybe, maybe not. What I am pretty sure is that there will be big moves in the future too. Don't forget that this company is still relatively small with a $2.5 market cap. I do know for sure, though, is that I will keep adding to my position on any dip.

If you liked this article and you want to follow my updates on Baozun, please hit the follow button next to my name.

In the meantime: keep growing!

Analyst’s Disclosure: I am/we are long BZUN, SHOP, BABA, SBUX, JD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.