In August, I released my first ever article for Seeking Alpha underlining why I believed JD.com's (JD) share price was undervalued. However, since then the stock has fallen by over 30% and its sentiment has turned very bearish.
Yet despite this, I still believe JD presents a great opportunity for investors. Although many events are used to justify why the stock has gone down, as Nassim Taleb says in his book The Black Swan (I am not using an affiliate link- just recommending the book!), this is hindsight bias. Investors are trying to make sense of what has happened by altering their view of the past, yet in reality, nothing has changed for the company.
With Singles day and the companies Q3 earnings report around the corner, I believe that the market is not correctly forecasting the bright future for this company, instead valuing it as if it was a stagnant or even dying retailer. We all know this is not the case, and my valuation of the company shows that many of the growth runways outside of its core retail sales aren't taken into consideration by the market.
Recent developments: Growing rapidly in core markets.
A couple of days ago the SA contributor Li Li released an article examining a recent report on China's phone sales growth. It showed that JD has managed to grow smartphone sales by a far wider margin than their competitors
This also corresponds to them growing retail sales at a far faster rate than their competitors.
These graphs show a picture very unlike what is typically shown by bearish articles on JD. Not only are they showing strong growth, but they are beating the market average by 2-1 in key sectors. This will allow them to continuously grow market share in the long-term, taking it away mainly from its bigger rival, Alibaba (BABA). This directly contradicts with the view that the company is losing its growth potential and is a reason to believe that current projections for this company's growth are wrong.
Singles Day: A catalyst for the share price.
Despite this continued growth for the company, the share price continues to stay low. This is mainly due to a complete lack of sentiment in this stock (and all other Chinese companies) which hasn't changed significantly since the start of the trade war.
One short-term event that could drastically alter this is Singles Day, the biggest shopping event in China which generates sales comparable to Black Friday and Cyber Monday combined. The date of the event is 11.11 however promotions have already started. This is why the news that the company Logged sales of 6 Billion RMB ($860 million) in the first hour is so exciting for investors. With products such as alcohol and beverage sales tripling, and smartphone sales doubling this is shaping up to be far bigger than the companies past Singles' Day despite the slow down in the Chinese economy.
If they can manage to close the gap or exceed their previous year's sale compared to Alibaba ($19.1 to $25.4 billion) then it would signal that they are continuing to both grow strong, and outpace the competition. This would allow some of the fears surrounding the company to disappear, and would result in the share price rallying back to the $30 dollar range in the near future, and much further in the next 12 months.
When one looks at JD, it can be hard to give it a definitive valuation. This is due to the unpredictability surrounding its razor-thin margins that mean that it produces almost meaningless profits. Because of this, it is better to look at how much the market is valuing each sale at, since it is higher sales that will allow for higher profits once JD focuses on profits over growth.
As we can see, JD's sales are now valued at their lowest amount since the companies inception. This is despite them growing greatly in the last 3 years.
When we compare this to a retailer such as Walmart (WMT) we get a similar picture.
Due to the run-up in their price over the last few years, Walmart now has a higher P/S ratio than JD. This is despite them growing at a fraction of JD's pace (did I mention that they are expected to grow revenues by over 25% this quarter, typically their weakest one!) I am not saying that Walmart is a bad investment, but it is clear that the market has excessive pessimism for a company that is still growing greatly.
Furthermore, unlike your typical high-growth company, JD.com is profitable. Although their PE is currently high, their forward PE is just 27. This is more than reasonable considering that they are not focusing on profit growth currently. Similar to what Amazon (AMZN) has done in recent months, JD could easily ramp up its numbers to show greater profits. But by instead doing so many promotions and discounts as it has done, it has managed to achieve a greater market share in key areas.
Ultimately, this should reward investors into the future once the market takes into account this tremendous growth and profit potential. Just a 2% margin and a PE ratio of 25 would account for today's share price (assuming 2018 revenues of $70 billion) This is without me taking into account the various other assets that the company owns, most important being its over 500 warehouses and the land that it owns throughout China. It also doesn't include stakes in businesses such as JD Finance, which is worth at least $5-10 billion on its own (current valuation of $20 billion in which JD gets 40% of the profits. Source), and in many other international retailers such as Farfetch (FTCH), which recently held an IPO and is worth over $6 billion (of which JD owns 14%. Source)
If you account for this, you can easily see why the stock price is currently undervalued. Although I do not like to give precise estimates, I see the stock quickly bouncing to the $30-40 range once a catalyst (good earnings, trade war is over etc.) takes place. This is one of the many victims of the recent geopolitical landscape and so should benefit greatly once the tide changes.
For the sake of not repeating myself too much, visit my article on Alibaba last week. Most of the issues causing JD to be a risky investment apply to all Chinese companies and I talk about these more generic risks there. Here are some of the more company-specific risks:
- They do not achieve profit margins of between 2-5% for many more years than expected. This could cause the share price to stay cheaper than it should be even if the company continues to invest in the right ways to maximize shareholder value. Think Amazon if it didn't have such a strong investor base.
- They do not continue holding their own against Alibaba/start to lose market share in key areas. This would ruin one of my main thesis points around the company and would result in them being merely a cheaper Walmart (with much higher risk), as opposed to a cheaper Amazon. As I have shown this doesn't look like it will be the case in the foreseeable future.
- They lose their technological advantage. Although I have not mentioned this in too much detail here, the main reason customers buy from them is not price, but quality- think Apple (OTC:APPL). Without this, they wouldn't be able to charge higher markets than the competition and would fall victim to the failure of many similar companies in the retail space
- Key man risk- Richard Lui, the CEO of the company, owns the majority of the voting power and effectively makes all the (important) decisions at JD. If for whatever reason he couldn't work, it would (at least in the short-term) negatively affect the company.
In conclusion, I will admit that I was wrong when I previously talked about JD. Although I believe that the price was undervalued, even at $32, it is clear that the margin of safety was low enough that some unfortunate news caused the stock to drop.
Yet as I said at the start of the article, the reason for its decline is just news. It has a very little effect on any predictions from the last few years on the company. Investors are trying to explain a big drop with small problems, and this is the reason why I believe that JD's stock price is both irrational, and a great buy at current prices.
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Disclosure: I am/we are long JD, BABA.
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.