JD.com: A Better Quarter, But Still Avoid

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About: JD.com, Inc. (JD)
by: Michael Wiggins De Oliveira
Summary

Q1 2019 saw a strong improvement in its gross margin.

Top-line growth rate continues to decline at a rapid clip.

Unsustainable free cash flow improvement.

Ultimately, JD.com is overvalued.

Investment Thesis

It's no secret on SA that I'm bearish on JD.com (JD). My stance is that investors are being asked to overpay for unstable business.

Although Q1 2019 earnings delivered have some positive elements, the overall picture continues to be grim.

Investors are best to avoid this investment.

Q1 2019 - Good News

JD.com posted close to 21% on the top line. Furthermore, a strong focus on efficiencies, particularly on its first-party logistics service lent itself to JD's 20th consecutive quarter of year-over-year retail gross margin expansion. JD.com's gross margin hit 14.8%.

Additionally, greater scale together with reduced losses on JD's third-party logistics services allowed JD to see its EBITDA jump from RMB1.6 billion ($230 million) to RMB3.2 billion ($500 million). However, that's where the good news ends.

Amazon vs. JD.com

Many shareholders wrongly assume that JD.com is going to be the next Amazon (AMZN).

Granted, JD.com's business model is very similar to Amazon's. Both companies operating via a similar overarching strategy. Also, both companies set out to acquire the whole vertical of their operations which culminate in razor-thin profit margins.

Personally, I'm not a fan of investing in Amazon (AMZN), as I don't believe that investors can make sufficient upside potential. Having said that, the truth of the matter is that, despite Amazon's size, its top-line growth rate continues to be fairly stable.

Accordingly, let's take a step back and see how JD.com's growth rate compares with Amazon.

Source: author's calculations

As we can see, JD.com's growth rate continues to rapidly decline. Looking back 2 years ago, and JD.com was posting growth on the top line of 40%. Then, in Q1 2019, as we have discussed already, its revenue growth rate was much closer to half this amount, at 21%.

Given the pace of its top-line decline, I have to argue that its business model does not appear to be all that stable.

One-Off Free Cash Flow Boost

When I saw that JD.com free cash flow went from negative RMB8.9 billion ($1.3 billion) in Q1 2018 to positive RBM1.3 billion ($190 million) this time around, I was astonished.

However, upon deeper analysis, we can see two separate non-recurring events which caused improved its cash generation.

Firstly, the disposal of a real estate property assisted JD.com's capital expenditure turn to a source of funds, RMB 1.1 billion ($158 million). Secondly, a 66% reduction in its investment into its Beijing headquarters also assisted its cash generation this time around.

However, let me be clear. On the one hand, there was indeed a marked improvement in JD.com Q1 2019 cash generation, while, on the other hand, I contend that shareholders are overpaying for JD.com.

Valuation

Source: author's calculations, morningstar.com

When I highlight the above table, readers often declare that JD.com is trading at a terrific bargain, given that its cash flow from operations (before capex) is priced at less than 10x. More so in fact, when compared with its peers, which are priced above 22 times.

However, there is a couple of reasons why these numbers are misleading. Firstly, as discussed above, JD.com growth rate is substantially more unstable than that of its peers.

Secondly, unlike some of its peers, such as Alibaba (BABA), JD.com is extremely capital-intensive, with large capital expenditure requirements.

Takeaway

On balance, JD.com has had a better quarter than it has had for a long period of time. However, I passionately argue that its present valuation offers investors no margin of safety, as its share price is reflective of investors' sentiment that JD.com could in time be the next Amazon.

However, let's be honest: Amazon is a firm outlier. It is somewhat delusional to expect JD.com to be the next Amazon.

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.