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Editor's note: Seeking Alpha is proud to welcome Nicholas Carr as a new contributor. It's easy to become a Seeking Alpha contributor and earn money for your best investment ideas. Active contributors also get free access to the SA PRO archive. Click here to find out more »
Editor's note: Seeking Alpha is proud to welcome Nicholas Carr as a new contributor. It's easy to become a Seeking Alpha contributor and earn money for your best investment ideas. Active contributors also get free access to the SA PRO archive. Click here to find out more »
Earlier in the week, JD (NASDAQ:JD) announced its Q4 earnings. The stock was hit, substantially, and is currently trading around 11% down from its one month high of 48.96.
The drop appears to be due to the contraction in operating margin for the quarter leading to lower than expected EPS, along with a rather negligible revenue miss. I feel the sell-off is grossly overdone and intend to put my thoughts across in this article, while zooming out to look at the overall China e-commerce picture.
China's Online Shopping Addiction
The reason I first invested in JD, back in December 2015, was to buy a ticket to coast on the enormous tailwinds supporting Chinese online retailers. These are still there today. My first statistic is one of online shopping penetration rates across the world.
(Source: Statista.com)
As you can see, China leads the way with 83% of the online population buying a product online in the last month. Interesting: online shopping is obviously well embedded in Chinese culture - but surely this just means new customers are going to be harder to come by?
(Source: internetlivestats.com)
This statistic demonstrates where that customer growth is going to come from. Internet penetration in China is only 52.2%, compared to the 88.5% in the U.S. This means there are 660 million Chinese potential customers who will come online over the coming years into a population who shop online more than any other.
This is what gets me excited about Chinese e-commerce players. These non-users coming online could fuel big growth for a long time to come. (Keep an idea on India too!)
The market, as you'd expect, has been growing rapidly:
(Source: China Internet Watch)
Who's got a piece of the pie?
(Source:China Internet Watch)
China's e-commerce landscape is fragmented. Tmall, owned by Alibaba (BABA), is dominant, with JD in second place. Below these two big players come some smaller outfits, including Vipshop (VIPS).
Now, here is where I believe the value in JD is found. The widely accepted narrative from the investment community on China's e-commerce outlook is that there can be only one king - only one 'Amazon'. The market has decided that Alibaba will be this king, and has almost written off JD as an also-ran, with no potential for growth, doomed to be ground down relentlessly by competition with Alibaba.
I believe the narrative is wrong, and there can be two (or more) dominant e-retailers in China. Just because Amazon (AMZN) is the 'one king' in the west it doesn't mean things can't be different elsewhere. I believe JD has the critical mass: the brand recognition, the customer base and loyalty, the reputation, the partners (more on this later) and most importantly the logistics network to survive and indeed thrive.
As a sidenote - there is little threat of Amazon taking any market share in the coming years. The Chinese government have very little interest in allowing a U.S. company entry into its markets and it has just a sliver of the pie right now.
Why JD?
JD is the smaller player in its battle with Alibaba. It does hold some cards, however. Many Chinese customers recognise JD as the most trustworthy retailer - while worries about counterfeit goods linger over Alibaba's marktplaces- and also as the retailer with the best, fastest delivery service.
I believe that in online retail the vast costs incurred to set-up a working logistics network are the best moat for those who already hold one, and JD's is the best in the business. Indeed, JD plans to spin off and float its logistics arm, and recently raised $2.5b by selling just an 18.6% stake. This highlights the inherent value of their vast, efficient logistics network.
JD is also backed up by a bigger brother or two: China online giant Tencent (OTCPK:TCEHY) owns a 21% stake in JD and has entered into myriad partnerships and joint ventures with JD. Tencent dominates the Chinese online ecosystem and can utilise this to drive business for JD - for example by making it an exclusive shopping channel within it's WeChat mobile wallet. One of the joint ventures was a recent investment in to Vipshop (JD now owns 5.5% of VIPS) that I feel is a great deal for all involved and could power growth for all three companies. Walmart (WMT) owns a ~12% stake in JD also.
Beyond this, there is another glaring reason to own JD: It is growing… fast.
(Source: Seeking Alpha)
Firstly, revenues. To see a company the size of JD growing at 40% YoY is rare.
(Source: Seeking Alpha)
Secondly: customers. Last year's ~29% growth in active customer accounts is huge. On the right, you can see that the average number of purchases is also trending upwards steeply as customers trust the platform more and get more used to online shopping.
This, together, leads to higher free cash flow:
(Source: Seeking Alpha)
An important consideration here, and in my eyes the cause of the recent earnings miss, is that JD spent a lot on CapEx last year, and in particular in the final quarter. This was mainly for warehouses (because of growth) and other logistics spending - they built 81 new warehouses in Q4 alone and now cover 99% of China's population.
Earnings and profits are just not important to the JD board at the present time - they are ploughing almost everything back in to generate future growth. They have said many times that they plan to gradually raise margins over the coming years, and for me - an investor with a timeframe of longer than one quarter - I am more interested in long term growth than chasing quarterly EPS. This was Amazon's approach over its earlier years and we all know what ended up happening there.
Valuation
Let us take a look at JD's valuation and key stats compared to peers. I am not going to look at any earnings based ratios for the reasons above. Instead I feel price/sales is a better metric to focus on.
(Source - author's own table)
As we can see, on a p/s basis, JD is valued at a fraction of Alibaba, far less than Amazon and almost as low as minnow Vipshop - despite all the unique advantages and partnerships I've described above, and it's mammoth growth prospects.
It's important to note that this isn't an apples-to-apples comparison: Alibaba's business model is different (JD functions more like a conventional e-retailer, fulfilling orders itself, while Alibaba connects other businesses with customers in its marketplace) and allows better margins. Also I accept Chinese stocks do deserve a discount in comparison to a U.S. stock like Amazon.
I'd argue, however, that in both cases that discount is well overdone, especially after the recent sell-off. I believe an investor today, with a time horizon of years and not weeks or months, could be buying in to a potential multi-bagger. I believe the spin-off of JD Logistics is a possible catalyst for uncovering value to the investment community, and I feel the various partnerships with and support of Tencent (and Walmart) deserve real recognition.
Incidentally, I don't necessarily see Alibaba as overpriced, and watch Vipshiop carefully - I can see the latter being subject to a Tencent / JD takeover in the not so distant future.
Overall, though: let the Chinese internet penetration tailwinds do the work for you - JD is positioned brilliantly to take advantage.
Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
