JD's B2B Sales Strength To Keep Revenue Growing

Summary

• Decline in active customer count masked strong growth in JD's B2B sales, which doesn't contribute to active customer count.
• JD's offline franchise model is a cost-effective way to grow sales fast with low fixed asset investment risks.
• JD is undervalued considering its stakes in JD Logistics and JD Finance, its net assets, cash flow, and its warehouse and land holdings.

JD.com (NASDAQ: JD) released Q3 earnings report on November 19. It shows active customer count for the quarter declined by 8.6 million, while total revenue is up 25.1% yoy. Excluding the 49.4% increase in net service revenue, net product revenue grew by 22.8%. The decline in active customer count most likely is due to the weak demand for big ticket items amid the macro economy slowdown, and the front-loading of sales to the previous quarter leading into the company's big annual June 18 promotion.

Yet, how did they manage to sell more products to fewer customers? One key contributor is the growth of their business customers, including JD convenience stores, JD electronics and appliance stores, and other third-party stores that may or may not share JD branding.

One evidence is that JD xintonglu ("new road" in Chinese), their arm for handling sales and logistics to convenience stores, JD branded or not, reported sales increased by 10 folds during the Nov. 1-Nov. 11 Singles' Day sales event (report only available in Chinese), and sales by JD electronics and 3C stores increased by 422% for the same period year over year (report only available in Chinese).

Another eye-catching development recently is that on Nov. 27, China Mobile's (NYSE:CHL) subsidiary in the Jiangsu Province announced (report only available in Chinese) that it will use JD's systems to order, manage, and deliver merchandise, mostly cellphones and accessories, sold through its more than 20,000 stores in the province. China Mobile is China's largest cellular carrier, and JD has over half of the market share in online cellphone sales and the best logistic networks in the country. China Mobile will be able to lower cost, and JD will be able to further expand its market share through such deals.

Like these China Mobile shops that are not owned by JD, the vast majority of the JD convenience and appliance stores are also franchises owned by 3^rd parties, with the exceptions of a handful of JD zhijia ("JD Home" in Chinese) stores, the company's flagship stores similar to Apple (AAPL) store, and JD cashierless convenience stores similar to Amazon Go (AMZN). These franchisees place orders with JD which will then deliver the merchandise to their storefronts. While each of these stores may count as one customer in the quarterly report, retail customers who buy things directly from these stores will not be counted as JD customers.

Since JD launched the first JD convenience store in late 2017, the expansion has been noticeable. While the company has not given out any official numbers, we conducted our own survey searching for JD offline stores in all 338 cities of China in August this year using Meituan Dianping's app, China's most popular food-ordering service and an imperfect proxy for yellow pages. We estimated there should be at least 5,000 JD convenience stores in the country. Other than the five big cities of Beijing, Shanghai, Guangzhou, Hangzhou, and Shenzhen, there are more JD convenience stores than 7-11 stores everywhere else. JD convenience stores have also reached from tier 1 to tier 5 cities.

JD was able to expand its convenience stores fast because it does not charge any franchise fees but requires a minimum amount of order from the shop and a deposit of 5,000 yuan (approx. USD$720) that guarantees everything sold in the shop is authentic. There are also convenience stores that do not use JD brands but order things from JD. Sales to all these convenience stores further boost JD's status as the number one seller of FCMG in China, helping it negotiate better terms with the brands.

The story is similar for JD electronics and appliance stores. Only that due to JD's stronger market positions in these categories, these franchisees buy pretty much everything they sell from JD. There are more than 10,000 JD electronics and appliance stores nationwide. During this June when the company had its anniversary promotion, sales of large home appliances through these stores accounted for 45% of total sales (report only available in Chinese).

The tremendous sales growth to these business customers is a result of JD's “boundaryless retail” offline push. As the online retail competition gets ever more fierce among Alibaba (NASDAQ: BABA), JD, and Pinduoduo (NASDAQ: PDD), JD's offline efforts will certainly be a hedge and cushion for their future growth, where JD's direct sales model and superb logistic networks will provide a significant edge over their competitors. These B2B sales also tend to have lower delivery cost per unit since merchandise are delivered in bulk quantities to a storefront which operates in fixed hours, unlike individual customers who may not be available to receive the item until after multiple phone calls and visits.

With the stock trading around US$21, JD is incredibly cheap at a market cap of US$30 billion. JD's share of JD Finance was valued at US$4.6 billion, and its share of JD Logistics was worth US$10.9 billion in the latest rounds of funding. The company also has a clean balance sheet with cash and investments more than enough to cover debt. It owns almost $5 billion worth of hard assets, the majority of which being land and warehouses with market values far exceeding their book values (JD Logistics does not own these land and warehouses). This is also a company that generated $2.7 billion in operating cash flow in the trailing twelve months amid a dramatic economic slowdown.

As a growth company in a fiercely competitive business, JD requires a lot of patience from its shareholders. We believe JD has built a deep enough moat to survive Chinese economic slowdown and will thrive when the economy eventually recovers.

Analyst’s Disclosure: I am/we are long JD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.