Vipshop Enters A Slower Stage Of Growth

Summary

• After enjoying strong and stable growth, I believe Chinese ecommerce firm Vipshop is facing numerous headwinds.
• Client growth and profit margins are declining as competition in the industry ramps up.
• I don't believe this can change; Vipshop seems to have hit a ceiling as to how large it can grow.

Discount fashion ecommerce platform Vipshop (NYSE:VIPS) will report its second quarter earnings later this month. There are two key areas to watch for: I have concerns about its user growth and how long it can maintain its already-low profit margins.

Hiding the slowdown of user growth

Call me a cynic but when a firm, which consistently reported quarterly active users, decides to only report yearly active users, it suggests that user growth might be declining. That’s exactly what Vipshop did in 3Q16. Although quarterly active users can still be backed out, to me it is a form of deception. These concerns are supported by the trend of quarterly active user growth: it becomes notably more volatile and seems to have hit a ceiling of 30m users since the company stopped reporting the figure.

The volatility in quarterly active users began in late 2015, and it's clear that instead of the smooth and stable growth from before, the user base grows in the second and fourth quarter, and declines in the first and third. Unsurprisingly, the second and fourth quarter of every year have China's biggest ecommerce sales events. It suggests that Vipshop's user base is more fickle than before, swayed by prices available as opposed to user experience.

Vipshop’s quarterly active users (users that make a purchase in the period) before and after the company stopped reporting the figure in quarterly earnings calls. Units: millions of users. Source: Vipshop investor relations.

There are reasons why user growth would be slowing, based on the demographics that the company has targeted. Vipshop is popular in Tier 2, 3 and 4 cities, which are relatively poorer, more rural and less served by brand names than larger (Tier 1) cities like Beijing and Shanghai. Therefore, selling off-season, unsold branded fashion apparel at a discount is attractive to this user base.

But there’s a limit to this growth for several reasons:

• Geographic expansion: it’s a business model that doesn’t really work in larger, wealthier cities that already have good access to branded fashion apparel.
• Larger rivals sell fashion apparel: the likes of Alibaba and JD.com work with fashion brands to sell their products, and these platforms have much broader distribution networks throughout the whole of China.
• Urban migration: this is often something associated with people moving from the countryside to the cities, but it is also happening from lower tier cities to higher tier cities.

Nevertheless, the slowdown in active user growth isn’t having an effect on average user metrics. The total orders per customer have always fluctuated around 3 orders a quarter, and the average revenue generated from each user has been steady, only really increasing above RMB700 ($107) a quarter in the fourth quarter – which always has positive seasonal effects from Singles' Day.

The average revenue generated by quarterly active users, and the average number of orders placed per quarterly active user. Source: Vipshop investor relations.

User attrition would be acceptable if average revenue spent and/or orders per user increases as a result – the lowest, most inactive users are leaving. There has been a slight uptick in both since 2017, but I’m not entirely convinced that this is the case with Vipshop.

Razor-thin margins are moving downwards

To support the idea of declining user growth, profit margins are beginning to fall. Vipshop’s strongest growth period was between 2013 and 2015 – when client growth was its most stable – and profit margins corroborate that; the firm reached profitability in 4Q12 for the first time. But since 2016, an interesting trend has emerged. Operating and net profit margins were essentially the same prior to that, but non-operating expenses have crept up – net interest expenses and impairment losses on investments are now a staple. That’s not unusual, but the company is operating at razor-thin margins – between 2% and 6% for both ratios. On this downward trend, there isn’t much more scope for rising expenses.

Operating and net profit margins over the past six years. Source: Vipshop investor relations.

It's worth stating that I like Vipshop as a firm because it has successfully carved out a niche position in China's ecommerce industry. Vipshop - despite the issues discussed above - is doing much better than other niche players. However, it is very difficult to compete on price and delivery speed with Alibaba's (BABA) Taobao and Tmall, and JD.com (JD). Declining client growth and profit margins would support this competition.

Second quarter earnings expectations

Ultimately, it seems that Vipshop is entering a new stage of its publicly-traded life: strong and stable growth has now been replaced with stagnation.

Quarterly revenue and net profit for Vipshop. Source: Vipshop investor relations.

Historically, Q2 tends to see the highest revenue of the year, after the fourth quarter, so we should see quarterly revenue growth. Net profit is a little more unpredictable, but I expect that we’ll see operating margins above 3% and net margins at 2.5%. This would be a continuation of the slowing profit margin trend. As for client growth, the second and fourth quarters tend to see the highest growth of the year, so I expect a rebound to 28m quarterly active users for the year.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.