Ah, Baozun (BZUN). This is my 10th article on the company and its stock on a total of just above 100. I think that already shows how committed I am to bring news about this stock. It is probably the stock I have studied most of all. I did my first purchase at $17 and was able to average down before the stock went up considerably, and I started averaging up. Because of the big gains, Baozun has grown to become my biggest position and I am still very comfortable with that, even with the big volatility of the last year, with a low of $27.81 and a high of $67.41. The stock is trading a little below $35 at the moment of writing, $34.94, after a substantial drop on Thursday.
Wednesday, after the earnings were announced, the stock did a few strange moves up and down, but eventually only lost 1.40%, which is a tepid reaction for a stock that tends to go up or down 20% after earnings. The investors didn't seem to know what to make of the earnings:
As you can see, the stock was up more than 8% in the morning (to $43.82) and down to $37.12. The daily volume that traded hands was much higher than normal too: almost 8 million shares versus 1.7 on average.
I was already working on this article on Wednesday, and I already had the title: Baozun, Calm Like A Bomb in mind, indicating that the reaction of the stock price was temperate and that Baozun has explosive growth. Good title, I thought. But then today...
What happened there? Nothing really much actually. All Chinese stocks are down: Alibaba (BABA) -3%, JD.com (JD) -4%, Huya (HUYA) 7%, Momo (MOMO) -7%, Weibo (WB) -7.5% etc.). I think it has to do with the trial Huawei has filed against the American government: "Huawei Sues U.S. as a 'Last Resort' Over What It Calls an Unfair Ban".
I think a lot of investors are worried that this will become an important element in the trade talks. I don't think so, because if the Chinese government would support Huawei too much here, it actually proves the point that the American government makes: that Huawei is backed by the CCP (Chinese Communist Party). So I think this is a minor incident over the long-term, although it could bring down the prices of some Chinese stocks again. All the better for investors who focus on the long-term: they can scoop up shares at lower prices.
In this article, I will not pay too much attention to the 10% drop in Baozun, since I think it is unsubstantial over the long run. It's just a knee-jerk reaction to the news of the Huawei trial. This article will analyze Baozun's earnings to see what investors had difficulty agreeing on.
The miss and the reason
"Baozun misses by $0.04, misses on revenue". That is the title that most of you have seen here on Seeking Alpha. That doesn't look good; it doesn't feel good, such a headline.
The Q4 Non-GAAP EPADS (EPS for ADS) came in at $0.50, missing estimates by $0.04. The GAAP EPADS of $0.46 even missed by $0.05. Revenue came in slightly lower than expectations too: $320.36M (+40.7% Y/Y) versus $323.5M. That is a miss of less than 1% actually, which I call meeting expectations, especially because there is a slight fluctuation in the RMB to dollar rate.
So the main issue was the earnings miss. I think the management came up with a simple and actually good explanation. This is from the Q4 and FY 2018 earnings call. The first part is Vincent Qiu, Baozun's CEO, speaking, and then Robin Lu, new CFO, takes over:
So for the operation side, we invest in technology and the logistics and the supply chain to serve a broader base of potential clients. So that is about the operational and the strategic thinking. For the financials impact…
I will take the -- about the financial impact. As you see with the likely higher growth in the technology investment in 2018, we don't expect to have a significant growth in 2019. We'll be relatively slight flagged for the technology investment
In other words, Baozun has invested more in technology and logistics. If you don't want a growth company to invest in its core strengths, I don't think you should hold a single growth stock in your portfolio.
Baozun's CEO Vincent Qiu - Source
To be more precise, these are the areas that Baozun has invested in: sales and marketing are up 59% YoY, fulfillment expenses went up by 51%, and technology and content by a whopping 87%. But Vincent Qiu emphasizes that this is necessary to capture market share for the coming years:
Technology remains a key strategic focus of ours, as we increasingly devote more resources towards expanding our technological infrastructure and hiring the industry's best technical talents for our innovation center in order to drive future growth. Demand for our proprietary cloud-based platform in particular is growing with more and more premium brands leveraging this sophisticated platform to rapidly establish their online presence, creating new ways for us to increase brand value and help brand partners to improve efficiency and reduce cost.
These same technologies also help us to greatly improve our operating efficiency and strengthen our position within the industry.
And for the high marketing expenses, Robin Lu had a sensible answer too, in my opinion:
And about your second question, you talked about the marketing. I think that's a mixed factors for the marketing expense. The first one, we recall from the middle of 2017 we start to do the digital marketing service, which almost tripled its revenue but it's still in the ramp-up stage. It's in the lower margin, which has some impact on our total marketing expenses. But we think that's a strategic initiatives, for example our way -- part of our new brands we acquired we just start with marketing service and then we acquire them as our GMV brand.
The second one with the ramp-up of the digital marketing services, we think we have greater opportunity to improve the margin of the service. And also for the invested brands with more service we will have better take rates. So it's the strategic initiatives we do.
Invest now to reap the benefits later. That is what all growth companies must do, and that is what Baozun does with big success.
As a sidenote, I thought that Robin Lu, the new CFO of Baozun, gave a good impression on the call, especially during the questions. He referred several times to the past, which means that he has been studying the company and its initiatives very well. I was pleased to see him bring the information confidently too.
The total revenue was RMB2,201.9M (or $320.3M), up 40.7% YoY. But, as I have argued before, revenue on its own is not the best metric to judge Baozun, although the 40% growth is of course great.
But Baozun is in full transition to a new model, in which it doesn't own the inventory anymore, but it focuses on services, which are much more profitable and less risky.
The company focuses more on the Service Fee Model (A) and the Consignment Model (B) and less on the distribution model (C):
(Source: Baozun Investor Relations)
You could say that A is what Shopify (NYSE:SHOP) does: taking a fee for digital services; B is, as it were, FBB (Fulfilled By Baozun); and C is Amazon's (NASDAQ:AMZN) original model: owning the stuff that you sell.
But because of the shift to non-distribution sales, this has an influence on the revenue. The product sales revenue is gross and the services are net and therefore revenue growth seems to have slowed down.
The more the company can switch to the services segment, the lower the sales growth will be and the higher the profit margins. Because services are a model that are more asset-light as opposed to the inventory ownership. For the distribution model, you need big and expensive warehouses and workers to pick the orders or investments in robotized systems to do that job.
And you can see the distinction in the numbers: Services revenue was RMB1,226.6 million (US$178.4 million), an increase of 56.7% YoY, while sales revenue was RMB975.4 million (US$141.9 million), up "only" 24.6% YoY. That 56.7% is the real number to watch, and I think it is great!
In that regard the conversation between Monica Chen of Credit Suisse and Robin Liu, Baozun's CFO, on the conference call was telling:
Yes. Second question is regarding our CapEx plan and maybe more warehouse to add for this year?
We don't have CapEx plan for the -- for adding a warehouse this year.
Q - Monica Chen
Okay. So do we have any plan to maybe open more warehouses?
A - Robin Lu
So over the long term, Baozun switches more and more to an asset-light model, which will allow the company to make its profit margins higher and higher. That bodes well for the future.
What was also remarkable was that GMV (Gross Merchandise Volume), which is essentially the sum of the price of everything an e-commerce company sells, was up 42.8% YoY to RMB12,037.7M. That is remarkable because when the company announced its sales of 11.11 (Singles' Day), the stock fell by more than 20% because sales "only" grew by 31%. I wrote an article about it then. I think that there is a certain Singles' Day saturation point that is coming closer and closer. This is again highlighted by the fact that for the whole Q4 2018, GMV rose by almost 43%, and don't forget that Q4 includes the Singles' Day. I will repeat my message of November: Singles' Day sales on themselves don't say that much. The bigger trend is much more important.
Even though Baozun focuses more on the non-distribution model, it doesn't do away with the distribution model. GMV still grew at 23.3%, mainly because the existing clients sold more. But Baozun is actively trying to convert clients to become non-distribution. So it is no surprise that the non-distribution GMV was up a lot more: 45.2%.
Also very important is the number of clients. As a general rule, you can say that the more clients a company has, the less risk there is. But in the case of Baozun, this is even more the case. For now (and we come back to that later) Baozun focuses on big clients: Microsoft (MSFT), NBA basketball, Huawei, Samsung (OTC:SSNLF) (OTC:SSNNF), Philips (PHG) and you see a lot more on this Baozun advertisement image:
Now, adding such big clients is, of course, no assembly line work. Therefore, it is a great performance that Baozun was able to bring up the number of clients to 185 from 152 in Q4 2017. That is a total of 33 new clients over the last year. Just to give you an idea: the average over the previous years was about 20 for a full year, as I mentioned in my article about Q3 2018 and the new CFO Robin Lu. 13 new brand partners were added in Q4 alone. So the number of brands actually accelerates, which is a very good sign for the future of the company. New brands need some time before they really start delivering great results, so the new additions will only start to fully deliver over the next few years. CEO Vincent Qiu on the earnings call:
As our reputation strengthens, so too are the number of global leading brands we are in talks with at the moment. We are seeing an increasing number of high-end brands approaching us to help them to execute their e-commerce strategies in China. We eagerly look forward to working with these brands to expand their presence in China's e-commerce market, where we expect to see their contribution to GMV steadily increase over the next two to three years.
For the whole of FY '18, the GMV was up 54% YoY to RMB29,426M (about $4.39B). This was mostly due to the high increase in non-distribution GMV, which rose by 60.8%, while distribution GMV was still up too: 10.8%. Non-distribution GMV is responsible now for 90% of the total GMV. Just a few years ago, distribution GMV was at 34%, so this is a very good evolution.
The guidance that was given for Q1 2019 was good too. From the press release of the Q4 and FY 2018 earnings:
We remain confident in our strategy and the effectiveness of our operations and services, and expect GMV to grow by 40% to 50% year-over-year and total net revenues to increase to over RMB7.2 billion during fiscal year 2019. For the first quarter of 2019, we expect GMV to grow by 55% to 60% year-over-year."
So the higher growth doesn't go away and was not an outlier. And Vincent Qiu reassured the investors:
While China's broader economy is slowing, growth in the e-commerce sector remains strong as an emerging base of increasingly affluent middle-class Chinese continue to drive consumption growth.
We strongly believe that the e-commerce industry and the digitization of retail industry will continue to grow at a faster pace than the overall economy, which we are ideally positioned to benefit from.
There has been much talk about China's slowdown, but all western countries would give an arm for such growth: 6%. But e-commerce will grow much faster than that, so Baozun is in the middle of an industry that will continue to grow substantially for years and years.
Future: great opportunities
Besides the fact that e-commerce in general is expected to grow exponentially over the next few years in China, there are two other trends that Baozun can take advantage of.
The first trend is that China wants to become more and more self-reliant and build out domestic demand. The income of the average Chinese has risen enormously over the last decades, and it will continue to do so over the next decades. So, while China's economy is still dependent on export right now, there will be more and more domestic consumption and that can only be good for Chinese companies.
Baozun has mainly western brands as its clients, but it will get more and more domestic clients too because of this trend. And it is ready for it. CEO Vincent Qiu on the earnings call:
Now we have multiple entry points to target the different clients including the domestic brands.
CFO Robin Lu added:
Additionally, at this moment, when we talk about the service with the local brands, most likely, we would utilize our technology and give more integrated service or comprehensive service to the local brands, which will naturally increase the margin.
The second trend is a trend I have written extensively about when it comes to Shopify: I call it, with the title of the book by Taylor Pearson, "the end of jobs" or maybe "the rise of the entrepreneur". You can read about it more in my article about Shopify.
In short, this trend holds that more and more smaller entrepreneurs will come to the market. They will skip the middle man and go immediately to their consumers. But of course, they need a platform.
We see that Shopify does extremely well with this trend. Now, in China, this trend has not really taken off yet, but it will in a few years' time. And Baozun will be ready for it. It has announced that the new version of its platform Nebula+ is also meant for smaller businesses, although they have not really followed up on it. I was disappointed that none of the analysts asked about the roll-out for smaller businesses, because I think it is a very important element for the future of Baozun. After all, it has been a year now, at the Q4 2017 results, that Vincent Qiu announced:
... we actually divided the software into two parts, one is for the largest brands and the other version is for smaller brands, all based on the same foundation for the new clients, no matter if it's big or medium sized or small, it all goes to the new release
Nebula+ has been released, but there is no talk yet of smaller businesses. The fact that Baozun still has this ace up its sleeve, only reinforces my confidence in the long-term potential of the company.
The Wall Street game of meeting, beating or missing earnings is a fool's game in my opinion. It is just a snapshot of what analysts are convinced of at a certain moment. Now, don't get me wrong. I think earnings releases and especially earnings calls are very important, but not the numbers game of missing or beating. As a long-term investor, I just want to know if my investment thesis still holds, if the company I am invested in keeps doing what I expect it to do.
For Baozun: yes, the thesis still stands like a house. The fact that the company keeps performing and keeps innovating is much more important than a 1% revenue miss or the earnings miss. As for the earnings, I repeat: it's because the company is investing in its core business. And despite that, it is still very profitable too, unlike lots of other growth stocks. The EPADS (EPS for ADS), after all, grew and grew substantially: $0.50 versus $0.42 in Q4 2017. That is 19% growth in earnings despite the high investments.
The diluted EPADS of Baozun for FY 2018 was $0.66. With a current share price of $34.94, that means that Baozun has a TTM P/E of 53, which seems to be very high. But the earnings of FY2019 are expected to be $1.52, according to finviz.com. That means that Baozun has a forward P/E of just 23, which is low for a company that is expected to grow its revenue and earnings by 30% and more for years to come. Sure, Baozun can miss earnings again. There are a lot of uncertainties: the general slowdown in the Chinese economy, the exchange rate yuan-dollar, the investments, etc. But even with earnings that might be a bit lower, Baozun is perfectly valued for any long-term investor.
Sometimes investors are nervous because of price moves of the stocks that they own, especially if the price move is down 10% as on Thursday, March 7. A lot of investors think that they have missed something because they are so often told that the price movements "tell something". Well, they only report about sentiment mostly. And in this case, the big drop didn't even have to do with Baozun itself, but with one of its clients, Huawei, and it will probably have no influence on Baozun's business results at all. All sentiment.
Baozun keeps growing very well on all metrics: number of clients, GMV growth, service revenue growth and even EPS. Mr. Market has been so kind to give another opportunity to buy an excellent company, a Potential Multibagger, at a cheap price.
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In the meantime, keep growing!
Disclosure: I am/we are long BZUN, JD, SHOP, BABA, MOMO, WB. 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.