JD.com: Profitable Growth On Sale

seekingalpha04-24

JD.com, a Chinese online retail marketplace, is one of the largest e-commerce companies in the world, ranking second in revenue behind Amazon.The company operates its own supply chain infrastructure, ...

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revenues and generated positive free cash flows, with analysts forecasting continued growth in 2024 and 2025.When subtracting tangible net equity out of the company's market cap, JD's already-low valuation multiples fall to a ridiculous P/E of 4.8 and P/FCF of 5.2.   MotoEd/E+ via Getty Images Despite operating primarily in China, JD.com, Inc. (NASDAQ:JD) is one of the largest e-commerce companies in the world. Its namesake retail platform ranks #5 globally in Gross Merchandise Value (GMV), only ~15% behind the #2 spot held by Chinese competitor Pinduoduo, operated by PDD Holdings (PDD). The third and fourth spots are held by Alibaba (BABA)’s Taobao and TMall platforms. Due to its focus on direct retail rather than serving as a middleman between buyers and sellers, JD.com ranks second in the industry in terms of revenue, trailing only Amazon (AMZN). JD.com has evolved from a mere e-commerce platform into a Chinese logistics giant with a vast shipping, processing, and storage network underpinning its core retail business. The company has invested significantly in logistics infrastructure and equipment in order to bolster its long-term future competitiveness while simultaneously taking advantage of an opportunity for vertical integration. JD’s asset-heavy model gives the company close command over its supply chain, enhancing quality control and cost efficiency. JD.com has both grown its revenue and generated positive FCF every year since 2016. Even amid ongoing economic uncertainty and consumer hesitancy in China, analysts forecast continued growth this year and next. Despite the long runway for growth ahead of both its country and industry, JD’s stock is priced at just 1.7x TBV and 11.6x net income. The price is simply too cheap for a profitable and growing company of JD.com’s caliber in my view. With share buybacks recently kicking into high gear, I believe it’s clear that management agrees. Operations JD.com’s operations span numerous sectors, but the company maintains a strict focus on e-commerce and logistics. JD describes itself as “a leading technology and service provider with supply chain at its core,” alluding to its asset-heavy logistics model and the globally-leading supply chain network operated by its Hong Kong-listed subsidiary JD Logistics. The company’s namesake e-commerce website is a business-to-consumer (B2C) marketplace through which JD sells a wide variety of retail products directly to Chinese consumers. Along with JD’s health and industrials operations, these e-commerce activities are dubbed the JD Retail segment. In 2023, JD Retail accounted for 83.7% of gross revenue and JD Logistics accounted for 13.9%. In addition to JD Retail and JD Logistics, JD.com owns a majority stake in Dada, a Chinese local delivery and retail platform, which JD took control of in 2021. The company has also provided venture capital funding to a number of start-ups, mainly in China. In 2015, JD acquired a 10% stake in software company Kingdee in a $171M deal alongside a strategic partnership agreement under which Kingdee would provide services to JD Logistics. In 2019, JD participated in a $283M funding round in Terminus, a smart city IoT company. Also in 2019, JD became the largest shareholder in Tiki, a Vietnamese e-commerce company with an asset-heavy logistics model similar to JD’s (and a competitor of Alibaba’s Lazada platform). JD.com has posted revenue growth each year since going public in 2014, and FCF has been positive every year since 2015. While JD’s growth has slowed significantly in the face of economic headwinds in its domestic consumer market, analysts expect revenue to grow 6.9% this year and a further 6.3% in 2025. These growth rates would represent an acceleration from the past couple of years. Moving forward, JD’s annual growth is likely to further improve hand-in-hand with China’s economic outlook. Chinese E-Commerce Pure Play JD is essentially a pure-play bet on Chinese online retail. There are several differentiating factors between JD.com and its key competitors that make JD a more concentrated investment. For one thing, Alibaba and Pinduoduo generate substantial revenues in the form of transaction fees on third-party seller transactions. JD generates substantially all of its revenues from first-party seller transactions. Since JD is the actual seller in substantially all of the purchases made on its platform, it has more intense exposure to the state of the Chinese e-commerce market and is more directly affected by changes in the profit margins on retail transactions. Another consequence of this first-party seller model is that JD.com features higher revenues and lower margins than its competitors. Another competitive distinction can be found in terms of geographical reach. Alibaba operates multiple international e-commerce platforms (including AliExpress) and Pinduoduo operates the young but explosively-growing Temu marketplace (of Superbowl ad fame). Unlike its chief rivals, JD operates almost exclusively in China. The company therefore represents a more concentrated bet on the long-term strength of the Chinese consumer. Moreover, Alibaba operates a host of businesses independent of the e-commerce industry, such as cloud services and media companies. While JD.com has invested in a number of other companies, industries, and even countries, the scope of these investments pales in comparison to JD’s bread-and-butter operations. Logistics Leader Another factor that sets JD.com apart from its competitors is the prized logistics network operated by its separately-traded subsidiary, JD Logistics. The company maintains a vise-like grip over its supply chain, operating over 1,600 warehouses and employing 200,000 couriers who deliver shipments for JD.com and other businesses and individuals. JD Logistics is one of the most powerful logistics brands globally, ranking ahead of the U.S. Postal Service in terms of brand value. In December, JD Logistics launched its new international express delivery service with direct shipments from China to 23 countries in Europe and North America. Last month, the company announced that this express service’s outbound shipment reach had been expanded from the 2 initial hubs, Guangzhou and Shenzhen, “to nearly every district within China.” Needless to say, centrally operating the supply chain gives JD a significant competitive advantage over its competitors. Unlike Alibaba’s Cainiao logistics segment, which contracts with a number of external service providers to meet its shipment needs, JD Logistics owns and operates its supply chain. Aside from cutting out the middleman and enhancing shipping efficiency, this approach also helps the company ensure quality control. Tangible Equity Equals 59% of JD’s Market Cap Like Alibaba, JD.com sits on substantial tangible book value that has the effect of slashing its net purchase price by more than half. The company’s market cap sits at $39.5B and TBV is $23.3B, yielding a P/TBV of 1.70. This ratio indicates significant undervaluation relative to both international and domestic competitors, Alibaba excluded. Consistent Cash Generation Atop its rich base of tangible book value, JD.com churns out substantial free cash flows year after year. The company has generated positive FCF every year since 2016 and has significantly grown its average FCF over time in spite of the ongoing consumer spending slowdown in China. Over the past 5 years, levered FCF has consistently sat in or around the range of $2B to $3B annually. TTM FCF is currently toward the top end of its historical range at $3.14B, giving the company a P/FCF multiple of 12.6. (The company’s TTM GAAP P/E ratio is a similar 11.6.) Subtracting out the 59% of JD’s price accounted for by TBV, its trailing P/E is 4.8 and P/FCF is 5.2. While JD.com operates at slim margins due to its business model, the company’s profitability has proven resilient through thick and thin and its net cash flows are unlikely to fall into the red anytime soon. Persistent Sales Growth JD.com’s revenue and gross profit have both increased every year since the company’s 2014 IPO, favorably distinguishing the company from Alibaba and other “mature” Chinese tech companies. While the revenue growth rate has slowed to the point of negligibility since 2022 amid consumption weakness in China, the green shoots of a growth recovery are already showing up in analyst estimates, which telegraph 6-7% annual revenue growth this year and next. I believe these forecasts have the potential to be vastly surpassed if the Chinese economy outperforms pessimistic consensus expectations over the next couple of years. Restructuring Shortly after Alibaba announced a restructuring plan in 2023 to reorganize and decentralize its businesses, JD.com announced a similar plan. Unlike Alibaba, JD.com is already a relatively streamlined business largely concentrated in domestic B2C commerce with two of its subsidiaries (JD Logistics and JD Health) already trading separately on the Hong Kong Stock Exchange. Nonetheless, management sees the potential for further optimization of the business structure. JD’s planned restructuring is tamer than the one announced (and later scaled back) by Alibaba, consisting of the anticipated spin-offs of two additional segments – its JD Property and JD Industrials units – in Hong Kong. JD.com will retain a majority stake in both subsidiaries under the restructuring plan, and I do not expect these moves to have much material impact on the parent company’s stock performance – for better or for worse. Share Repurchases & Dividends In March 2020, JD.com announced a $2 billion share repurchase program with a 24-month effective term. In December 2021, the Board added another $1B to the existing authorization and extended the program duration by 24 months to March 17, 2024. Last month, the company unveiled a new $3 billion, 3-year buyback program. While the previous repurchase authorization was only ~70% exercised, the company’s just-announced $1.2B of repurchases in Q1 2024 indicates that the new authorization is likely to be fully exercised. For context, this translated to the retirement of 2.8% of shares outstanding in Q1 alone. JD has also paid an annual dividend since 2022, with this year’s $0.76 distribution being paid 4/29 to shareholders of record 4/4. At current prices, the trailing dividend yield is precisely 3%, though investors today will have to wait a year for the next dividend payment. Coupled with the buyback program, in which activity is heating up, the dividend demonstrates management’s shareholder-attentive approach. Risks I recently analyzed Alibaba, a fellow Chinese e-commerce giant and JD.com’s primary competitor. Unsurprisingly, the risks faced by each company largely overlap. As my goal here is to summarize and expand upon that analysis more so than repeat it, I would encourage the reader to see the Risks section of my prior article for a fuller understanding of how I view the risk-reward landscape for the e-commerce industry in China. JD Is A Chinese Company Rightfully or not, I believe Western investors are heavily biased against Chinese stocks. In my Alibaba write-up, I discussed the China Factor and opined that the most acute long-term risks facing Western investors in Chinese equities are geopolitical. If political tensions between the U.S. and China were to boil over into an economic decoupling, the ownership interests of U.S. investors in Chinese assets could be compromised. While this risk may seem far-fetched, Western investors in Russian equities in fact systematically lost their ownership interests when the two sides decoupled their economies in 2022 – so it cannot be dismissed as impossible. I rate a potential Taiwan invasion as the most acute long-term risk to Chinese equities held by Western investors. In my Alibaba analysis, I also addressed the economic turmoil in China, opining that ongoing fallout from the real estate bubble is real but overblown and predicting that China’s long-term economic growth will continue to outpace that of the U.S. and Europe. As further support for this view, China just reported GDP growth of 5.3% in Q1 2024, far surpassing the consensus estimate of 4.6%. However, Chinese retail sales grew only 3.1% in March, missing estimates and suggesting ongoing consumer softness in the face of economic turmoil and deflationary pressure. Many China bears vociferously assert that macroeconomic factors make China uninvestable. To the contrary, however, it is far more likely that once these short-term factors dissipate, the profits of companies like JD.com (which is profitably growing despite the economic difficulties) will balloon higher. The China bears want to have it both ways, arguing that China is experiencing a devastating economic downturn and that this makes Chinese equities untouchable. In the case of profitable and growing companies like JD.com, this position is nonsensical in my opinion – for if a business succeeds in bad times, it stands to reason that it will thrive when times are better. Moreover, the Chinese economy is still growing quite fast by global standards. Unless one believes that the Chinese economy will begin progressively contracting from this point forward, JD.com’s persistent profitability only underscores its potential for even higher earnings when macro headwinds ease. For the record, China has not experienced a single year of negative GDP growth since 1976. In my view, those who believe the Chinese economy is in secular decline are living in an echo chamber. Lack of Diversification Relative to Alibaba, JD.com represents a more concentrated pure play on the Chinese consumer economy. JD is significantly less diversified than Alibaba in terms of both operational and regional scope. The company generates the vast majority of its revenue from the B2C e-commerce market in China, within which it maintains a dominant position alongside Alibaba’s TMall platform. Accordingly, the company’s future will ride or die on the strength of the Chinese consumer market. In my view, this is one of JD.com’s most attractive features, as I expect the long-term growth rates of China’s consumer spending and GDP figures to continue outpacing their equivalent global averages. Razor-Thin Margins JD.com’s revenue primarily consists of the gross proceeds of its retail sales, so its margins are low (and revenues high) as compared to third-party e-commerce platforms with fee-based revenue structures. JD’s gross margin is consistently ~8% and its operating margin sits around the 2-3% range. Accordingly, JD’s profitability could be vulnerable in the future; slight changes in its operating market could have an outsized impact on its net earnings. That said, the potential for earnings volatility applies every bit as much on the upside. The company’s depressed margins have also been attributed to consumption softness in China and ongoing subsidy campaigns to gain and maintain market share. With JD operating at such slim margins despite its unparalleled logistics network and massive economies of scale, it appears probable that margins will not go much lower. The company’s margins seem more likely to expand than contract in the long term. Dada Investment JD.com took a majority stake in local delivery platform Dada Nexus Ltd. (DADA) in 2021. Dada has lost a staggering 97% of its market value since its late-2020 peak, costing JD.com many billions in paper losses. In January of this year, Dada announced an internal investigation into suspicious accounting figures. Last month, the company announced that it had fraudulently booked a cumulative $150M+ of allegedly fake transactions from Q4 2022 to Q3 2023 in order to inflate its revenues and costs. The president of the company simultaneously announced his pending resignation. At best, the Dada investment has gone horribly wrong for JD.com. At worst, I believe JD’s controlling interest in Dada potentially means that it could share responsibility for the governance oversight. Competition JD.com is one of the top dogs within the Chinese e-commerce space, long trailing Alibaba alone in market share. However, competitive pressures have intensified, particularly due to Pinduoduo’s exponential growth. Pinduoduo exploded onto China’s retail scene in 2015 with the innovative strategy of offering large discounts on bulk purchases in order to encourage groups of consumers to purchase merchandise together. This strategy has been enormously successful, with the company now generating tens of billions in annual revenue less than a decade after its founding. PDD was recently praised by Alibaba founder Jack Ma for its “decisions, execution and efforts in the past few years.” Furthermore, Douyin (the Chinese version of TikTok) now markets over $200 billion in gross merchandise value annually to Chinese consumers. With smaller competitors growing much faster than Alibaba and JD.com (from a much smaller base), it is an inescapable conclusion that JD.com’s market share is depreciating. However, with the Chinese consumer market experiencing impressive long-term growth alongside GDP and income per capita, there is more than enough room in the market for all of the above companies to grow. Considering JD.com’s powerful brand, massive economies of scale, unrivaled logistics capabilities, and strong financial position, it is improbable that the company will be left behind as China’s long-term consumer spending continues to grow. Moreover, PDD is a more direct competitor to Alibaba than it is to JD.com, as its fast-growing Temu product competes with Alibaba’s AliExpress in Western markets. Final Thoughts Amid an unmistakable slowdown in its domestic consumer market, JD.com continues to exhibit growth and generate impressive profits. Leveraging its powerful logistics network and massive economies of scale, the company is comfortably entrenched in a top position within the Chinese e-commerce industry. Despite JD's solid track record of operational excellence and financial success, the stock trades at just 1.7x TBV and 12.5x FCF. Underscoring the company's strong financial position, management is buying back shares at a rapid clip in addition to paying an annual dividend. There are risks, of course, including the China Factor. In my view, however, China's economy has a long runway for growth ahead and the Chinese people have every incentive to realize their nation's economic potential. Despite its various short-term struggles, the fact of the matter is that China’s economy is still growing a lot faster than the economies of the U.S. and Europe.  JD.com is advantageously positioned within a fast-growing economy and industry. Its stock trades at a high-single-digit earnings yield. Its low valuation multiples would indicate that the company is at an unusually favorable point in its earnings cycle, yet Chinese consumer demand is cyclically depressed at the moment, stunting the company’s near-term growth but illustrating the potential for far greater growth in the future. JD.com has sterling financials and stands to continue benefiting from the long-term trend of fast-paced Chinese growth. 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