Updated: Aug 1
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JD is China’s largest online retailer that is synonymous with authenticity and fast delivery
It is founder-led and counts Tencent as a significant shareholder
Its extensive logistic infrastructure has built a strong moat on delivery speeds
Future JD Retail growth is expected to be driven by an expansion into Tier 3-6 cities
It has developed significant real option value
SOTP-based fair value estimate of US$92.88, representing a possible upside of 36.3%
JD is China’s largest online retailer based on net revenue that is synonymous with authenticity and standard same- and next-day delivery.
It has built its reputation of authenticity by combining a 1P model, where it controls the entire supply chain, with a 3P model that limits the number of sellers, to ensure that it can maintain strict quality oversight. This business model has cultivated customers' trust in the authenticity of its products which is a key reason for electronics and home appliances revenues, which tend to be higher-ticket items, accounting for 61.5% of JD’s FY20 net product revenue.
In addition, it has built out a proprietary nationwide fulfilment network which includes a last-mile delivery infrastructure to provide fast delivery at low fulfilment costs.
JD generates revenue from 2 business segments - Product and Service. Its Product arm generated 87.4% of total revenue through online direct sales (1P) by selling general merchandise, electronics and home appliances. While its Service arm generated 12.6% of total revenue through commissions on third-party marketplace sales (3P), advertising, logistics and other services.
It is estimated that the Chinese online retail GMV has grown at a CAGR of 32.0% from FY12 to FY20E and is expected to grow at a CAGR of 10.0% from FY20 to FY23 on the back of rising online retail penetration.
The Chinese e-commerce market is dominated by 3 players (Tmall, JD.Com, Pinduoduo) which together have about an 89.4% market share, out of which, JD.Com has a 26.5% share.
JD is led by its founder, Richard Qiangdong Liu, and Lei Xu, chief executive officer of JD Retail, who have navigated the pandemic well by significantly outperforming its closest competitor, Alibaba, as shown below in Thesis 1. Its founder owns a 14.8% stake in JD and is thus highly incentivised to continue JD's strong growth momentum.
In addition, the management's overall low-profile and soft media presence helps it avoid unnecessary trouble and public conflict with the Chinese government.
Its top shareholders include Tencent which has a 17.1% stake and has been active in growing JD's user base through strategic cooperation agreements where it offers prominent level 1 and level 2 access points on its Weixin platform to provide traffic support and also renewed its e-commerce-related non-compete agreement in 2019 to ensure synergies are maximised through their partnership.
Share Price Movement
From the start of 2020 to date, JD has enjoyed an 80.6% rise in share price on the back of a pandemic-induced surge in China's online retail adoption and a record inflow of stock market investments that partly fueled the run-up of the broad market. However, since hitting its 52-week high of US$108.29 in February 2021, JD's stock has pulled back by 37.1% on fears of increased scrutiny by the Chinese government on technology giants and the possibility of Chinese-listed ADSs being delisted from the US stock exchanges. In addition, the significant rotation from pandemic beneficiaries to return-from-home stocks could have exacerbated the decline in JD's share price.
1. Total revenue and net income
From FY16 to FY20, JD grew its top-line at a CAGR of 30.4% on the back of the continued strong growth of its 1P business and revenue from real options such as Logistics and other services growing quickly at a CAGR of 87.5%.
As a result of strong top-line growth, JD achieved profitability in FY19 and net income grew by 314.9% in FY20 on high operating leverage.
2. Total gross merchandise value (GMV)
JD has grown its Total GMV at a CAGR of 29.1% from FY16 to FY20 which was mainly driven by growth in TTM active accounts which grew at a CAGR of 20.1%. We expect an expansion in GMV/active account to further GMV growth in the future as online retail penetration growth continue to decelerate given that China already has a significantly higher digital penetration rate relative to other countries. We believe an expansion in GMV/active account is justified by the fact that the ARPU from the 2015 customer cohort increased by more than five times by 2020 and thus, as newly acquired customer cohorts mature, it is expected that they will cause an increase in total GMV.
JD has significantly lower gross margins than its competitors as its core retail segment is operated on a 1P-3P mix model compared to a heavily 3P-dominated model of Pinduoduo and Alibaba. JD's 1P segment that is operated at a mid-single-digit gross margin drags down its high margin 3P business which results in such a stark difference in gross margins from its competitors.
JD's fulfilled gross margin has expanded by 1.6% pts from FY16 to FY20 as it enjoyed increasing economies of scale from its 1P business and fast growth from its advertising service business. However, reinvestment in logistics infrastructure, especially in lower-tier cities, as well as a decline in 3P take rate in 4Q20 were a drag on fulfilled gross margin.
In addition, when we separate JD’s retail segment from its new businesses, we can see how the non-profitability at the operating level of its new businesses drags down the overall Non-GAAP net margin. Thus, we believe this has obscured the market’s view of JD Retail’s actual operating margin and as the new businesses mature, the overall Non-GAAP operating margin should improve, which could catalyze valuation multiple expansion.
4. Negative working capital
JD operates a negative working capital structure as its inventory turnover days is much shorter than its accounts payable days. This allows it to internally finance growth and as cash increases with the size of operations, JD has been able to grow its net cash position YoY since FY16 despite significant investment in logistic infrastructure expansion.
1. Proprietary logistics infrastructure has built a strong moat on delivery speed
Thus far, JD has spent 14 years building its proprietary nationwide logistics network that includes its own last-mile delivery infrastructure. This is highly different from its competitors such as Alibaba which does not fully own its logistics infrastructure but instead uses Cainiao, an alliance-based logistics platform that allows for collaboration with logistics partners and couriers.
The significant investment of time and money into JD Logistics has created a strong moat on delivery speed which as seen from the chart above, cannot be easily replicated by third-party delivery service providers.
The moat of its logistics network was especially evident during the peak of the pandemic in China where JD significantly outperformed Alibaba in growth rates which we believe is due to JD's better inventory management as JD is heavily 1P-biased which allows it to better manage demand and supply. This is evident from the fact that JD's 1P growth rate was greater than its 3P growth rate by 8.0% pts.
In addition, JD had much shorter delivery lead times than Alibaba in part as JD could mandate continued high operating levels of staff, unlike Alibaba which has less control as it relies on Cainiao.
Given that working hours in China ranks amongst the top in the world, delivery speed is a key consideration of Chinese customers and JD's short lead time that is built by its proprietary logistics infrastructure is expected to help in continued customer acquisition and reducing churn.
Furthermore, by owning its logistics network, JD has been able to successfully lower the fulfilment cost per order by 27.6% from FY15 to FY19 which could attract more users to JD’s platform if fulfilment cost savings are passed on to customers in lower delivery fees.
2. Expansion of JD Retail into tier 3-6 cities provides headroom for revenue growth
As the Chinese e-commerce market enters a more mature stage, especially in Tier 1-2 cities, we believe that the bulk of JD Retail's growth will come from its expansion into the Tier 3-6 cities.
JD launched its lower-tier city targeted social e-commerce platform, Jingxi, in 3Q19 which has since launch, introduced more than 83.0 million new annual active users to JD.com. The success of Jingxi and continued penetration into the lower-tier cities saw an acceleration of 4Q20 overall user growth, of which 80.0% of new users in 4Q20 came from lower-tier cities.
Management has shown its intention in continuing in this direction by establishing the Jingxi Business Group in 4Q20, where it grouped Jingxi, Jingxitong (convenience store business), and Jingxi Pinpin (community group purchase business) to strengthen its supply chain capacities to better serve customers and empower SMEs in the lower-tier cities.
In addition, as a result of JD's cultivation of a higher quality product selection, it has often priced out the lower-tier city users. Thus, with the launch of Jingxi, it is expected that JD should be able to increase its share of Tier 3-6 cities e-commerce market. Furthermore, it launched strategic cooperation in 2Q20 with Kuaishou, which is a short-video platform that has 64.9% of users from Tier 3 and below cities. This cooperation will allow Kuaishou users to purchase products provided by JD without leaving the Kuaishou app, and hopefully, increase JD's penetration into the lower-tier city market.
3. High degree of optionality
We will analyse JD's optionality through 3 main segments, a) Geographic Expansion, b) Product/Category Expansion and c) New Businesses based on Shawspring Partners' optionality framework.
(a) Geographic Expansion
In 2018, JD Central was launched in Thailand in partnership with Central Group and has seen GMV grow by 550.0%. We believe that the carry-over of JD's distinct fast delivery speed and reputation for authenticity as seen from its high average order value of US$79.7, that indicates consumer trust in its authenticity of products through the buying of pricier items, have been key to its success.
Even though JD has not released exact financial figures from its international expansion into Thailand and Indonesia and is thus difficult to value on a fundamental basis, it was reported that JD Indonesia’s valuation exceeded US$1.0bn in 2020 and we expect JD Central to roughly grow into at least a third of JD Indonesia's valuation based on population size proportion alone. We portend that there could be further upside to this figure given that Thailand's nominal GDP per capita is 80.7% higher than that of Indonesia and thus, JD could be a better fit for Thailand as JD Retail has predominantly had a relatively high average order value and should better suit a higher income per capita country.
Overall, we believe there is significant real option value developed through geographic expansion that is still relatively unknown to the broad market and could thus serve as a re-rating catalyst if the above companies' valuations continue growing rapidly and make up more than 5.0% of JD's market capitalisation.
(b) Product/Category Expansion
JD has been continuously working on expanding its product range such as through JD Health which provides retail pharmacy and online healthcare services. JD leveraged its extensive logistic infrastructure and large user base to launch JD Health which was eventually spun off and is currently publicly listed at a US$43.7 bn valuation.
(c) New Businesses
In addition, JD has launched multiple new businesses that improve JD Retail. These include JD Logistics which was launched to provide faster delivery for JD's retail segment. Shawspring highlighted that in FY17, "JD's fulfilment expenses accounted for more than half of JD’s total gross profit but in reality were investments in logistics infrastructure" and thus, obscured the actual economics of JD Logistics.
Furthermore, as these businesses are set up with demand from launch as JD's core retail business is a client, such as JD Logistics, it allows the new businesses to gain scale and attract other customers after building a reputation. This self-sustaining JD ecosystem is starting to reap its rewards as seen from JD Logistics' expected IPO valuation of between US$30.9 - 34.0bn.
Through its continuous reinvestment, large user base and extensive logistics infrastructure, JD has been able to develop significant real option value through the above 3 ways that can be opaque and difficult for the market to put a value to at first but could add significant visible shareholder value in the future through a spin-off, IPO, divestment and other methods.
Applied WACC of 12.00%, which is higher than the Capital Asset Pricing Model cost of equity which yields a WACC of 10.95% as we err on the side of conservatism to buffer in the event of a continued rise in the 10-year treasury yield
Terminal Growth Rate of 2.5%, which is lower than the expected FY25 - FY30 China GDP growth rate of 4.5%
Overall GMV grows in line with the expected growth rate of the Chinese e-commerce market at a 6.7% CAGR from FY21 to FY25
We derived a fair value of US$57.83/share for JD Retail using a back-of-the-envelope Discounted Cash Flow (DCF) Model with the Gordon Growth Method. We believe there is a potential upside to the derived fair value as we used a conservative WACC and terminal growth rate. In addition, the overall GMV growth rate we assigned implies no gain in market share and represents a significant deceleration from JD’s historical growth, and is thus, conservative in our opinion.
JD Logistics goes public with a market capitalisation of at least US$30.9bn, which is on the lower end of the expected IPO range
Market Capitalisation of spin-offs and listed investments does not decline below the current valuation
20.0% holding company discount to err on the side of conservatism
With the above key assumptions, we derived a fair value/share of US$92.88 using a SOTP Model. This represents a possible upside of 36.3% from the last closing price of US$68.15.
This implied valuation heavily hinges on JD's listed spin-offs and investments retaining their current combined valuation. Given the possibility of a further government crackdown on fintech companies in China, we discounted 50.0% off JD Digits' (now under JD Technology) target valuation when it filed for IPO in 2020.
Overall, we believe JD is currently undervalued in part due to its complex company structure and fear of heightened government crackdown on oligopolistic businesses such as JD which we will analyse under the Risks section.
1. Successful listing of JD Logistics
JD Logistics has secured about US$1.5 billion in commitments for its IPO from investors such as SoftBank Vision Fund and Temasek. If it were to list at a valuation beyond US$30.9bn, it would unlock a significant amount of value as seen from the SOTP table above and provide liquidity to fund continued expansion of logistic infrastructure, especially in the lower-tier cities, which will link back to growing JD Retail.
Expected Date: 28 May 2021
2. Strong 1Q21 financial results
If JD were to post strong 1Q21 results and management gives good guidance for the year ahead, we think it would help to allay concerns of a post-pandemic drop-off in online consumption growth and instil investor confidence, especially in this volatile stock market environment.
Expected Date: 19 May 2021
1. Delisting of JD's US-listed ADS
The HFCA Act states if the SEC determines that JD has filed audit reports issued by a registered public accounting firm that has not been subject to inspection by the PCAOB for three consecutive years beginning in 2021, the SEC shall prohibit JD's shares or ADSs from being traded on a national securities exchange or in the OTC trading market in the USA.
In addition, on 6 Aug 2020, the President’s Working Group on Financial Markets (PWG) issued the Report on Protecting United States Investors from Significant Risks from Chinese Companies to the then President of the United States. This report recommended the SEC implement five recommendations, some of which are more stringent than the HFCA Act, for example, if a company was not subject to PCAOB inspection, the report recommended that the transition period before a company would be delisted would end on January 1, 2022.
Given that "China has long refused to let the U.S. Public Company Accounting Oversight Board examine audits of firms whose shares trade in America, citing national security concerns", it is possible that this threat and overhang will exist for the foreseeable future as President Biden maintains his firm stance on China.
However, one should note that even in the event of a delisting, the underlying cash flows that determine JD's valuation should not be affected and JD US-listed ADS holders who are fearful of a possible delisting event should consider owning JD through its HK-listed stock (9618.HK) instead.
2. Chinese government's crackdown on monopolistic/oligopolistic business
The Chinese government has increased its scrutiny over dominant technology platforms, most notably seen through Ant Group's IPO blocking just 2 days before the listing date.
This has also affected JD as its finance arm, JD Digits, had to be restructured as JD Technology following the Ant crackdown, but we believe JD to now be on the good side of the government as indicated by the successful IPO process of JD Logistics that is set to be the 2nd-largest IPO in HK in 2021. As noted under the management section above, JD’s low profile management should help it to avoid public conflict with the Chinese government and it has thus far, not encountered any publicly-known criticism by the government.
The current fear towards US-listed Chinese ADSs and JD's complex company structure has allowed JD to be attractively priced in my opinion. We believe its significant reinvestment opportunities, large total addressable market and distinct logistic infrastructure moat warrant a closer look by investors and we will be closely monitoring its Logistics IPO and upcoming 1Q21 results to gain more clarity on post-pandemic growth in the lower-tier cities.
Thanks for reading, Joseph Disclaimer: We are long JD.Com (NASDAQ:JD) at an average price of US$39.01. This article is not an investment (buy/hold/sell or otherwise) recommendation, this is only for educational and discussion purposes. This article is not tailored to the specific circumstances of any reader. I/we/The Snowball do/does not purport to be in the business of providing financial advice and the contents of the article should not be regarded as such. Cover Photo by Marcin Jozwiak on Unsplash
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