Fundamental write-up: $JD - JD.com
Hello! Since my Alphabet write-up I haven’t been able to write something, however I decided to make a write-up for my analysis on the chinese e-commerce company JD.COM. Like always, this is written based on my own business and fundamental analysis. Anything written here is my own opinions and you’ll do whatever you want with that information.
The company JD.com
JD.com is an chinese E-commerce company operating in a similar way that Amazon ($AMZN) did before Amazon branched out into various industries. JD is today China's largest retailer, selling everything they are able to online. This includes but is not limited to electronics, clothing, food, medicine and similar products. This makes JD a true one-stop-shop for most chinese citizens. The business focuses primary on online-retail, logistics networks and data-driven method development, which very closely mirrors that of Amazon's core business apart from their subscription model. Apart from their retail, JD has multiple daughter-ventures, like JD finance. JD finance is a financial arm of JD focusing on lending, credit systems, financial supply chains, payment methods and crowdfunding. JD runs China's largest crowdfunding site.
Fundamentals
JD is today unprofitable. In the year of 2017, JD held a revenue of $57 billion, which after cost of goods sold are payed end up being $7 billion. When the operating expenses are paid as well as the company reinvestments, JD sees a loss 1%. The core of JD:s business model right now is growth, and it does so at the cost of its margins. Gross margin of average 14%, and just slight negative net margins. Though all of that, right now JD is net cash positive with $3,3 billion in its war chest after debts are paid. The result of those numbers is that with the current rate of loss, JD will stay afloat for one year without taking on debt, raising more capital or adjusting its margins for the better. 14% of JD:s operating income is R&D and technology, and that number is increasing 45% per quarter (with the Q4 2017 having the massive increase of 75%). This number is a few % points below the increase in overall operating expenses, showing that their technology investments increase the fastests of any expense. This is matched by their revenue gain, which is 41% year to year. This amazing growth makes JD the fastest growing retailer in the country of China, growing right next to Alibaba which is the only retailer which matches JD:s growth. JD have over twice the current growth rate of Amazon.
Forecasts & predictions
JD has an incredible growth for a company of its size. A large portion of that comes from the fact that China have a huge event ongoing, which is the raise of the middle class. A huge number of households are raising itself from poverty into well-doing middle class. China's retail sales are increasing 11.3% per year, which is over double that of Americas (4,22% annual increase average y/y). This means that not only is JD:s market share growing, but the market as a whole is growing rapidly. This is the recipe for true growth, similar to that of which Amazon have done in US online sales. If we assume that JD:s revenue growth peaks next year (which is an extremely negative outlook), and then falls off 4% growth yearly until it reaches only 11% growth in 2027 and negative revenue growth in 2032 (with a -2% maturity from that point forward), we get a fairly negative view on JD:s revenue prospects. We combine this with an operating expense that matches the operating margin today, we see a company that has a net present value of nothing. This is the crux of fundamental analysis on unprofitable high-growth companies. JD:s growth numbers are fantastic. That is undeniable. However, the margins and reinvestments that are made today are unsustainable, which means we have to take a look at how we can predict JD to evolve.
Margin issues
Today JD holds a gross margin of 14%, which is extremely low, and a operating margin that is just negative. The only thing that makes JD a valuable business is the idea that one day they will increase their margins which is much easier said than done. A part of the massive growth that JD sees comes from their rapid expansion. They have to build offices, distribution centers, data centers, manufacturer relations, logistics networks and much more. Growth costs a vast amount of resources. So the key to profitability comes not from additional growth, but an improvement of their margins. This comes naturally as growth slows down, but to really improve takes work. The question is, where does JD end up if they succeed? We make an educated guess by looking at similar businesses. Amazon is a very similar business, which today sees a gross margin of 36%, over double that of JD. Another perhaps even more similar company is Alibaba, a chinese E-commerce platform which business model looks more like that of Ebay than Amazon. Alibaba holds a great gross margin of 57%, and have never seen a lower one. Amazon's’ lowest gross margin it has seen is 22%, which is quite a bit closer to that of JD:s. A last but less similar example is Walmart, known for razor thin margins, which has a gross margin of 25% (and its worst historically is 24%). This shows that it is possible to be a retail focused company with higher gross margins. So what this comes down to is can JD compete in pricing if it would increase its prices and therefore margins? How similar will JD:s path to profitability be that of Amazon? Will JD be able to do it before they collapse under its own expenses? These are tough questions.
JD
Gross margin: 14%
Lowest gross margin historically: 5%
Operating margin: 0%
Lowest Op-margin historically: -7%
Revenue: $57 Billion
Amazon
Gross margin: 36%
Lowest gross margin historically: 22%
Operating margin: 5%
Lowest Op-margin historically: 0%
Revenue: $118 Billion
Alibaba
Gross margin: 57%
Lowest gross margin historically: 24%
Operating margin: 30%
Lowest Op-margin historically: 25%
Revenue: $25 Billion
As you can see, JD:s margins are extremely weak compared to companies in the space, and a majority of that comes from their gross margins, which they maintain low to compete on prices.
Opinions, Price targets & Verdict
I think JD.com is a great purchase, however it does come with quite some risk. Today, the market prices JD as if in 2019 they will increase their gross margin by 1% until 2024 they reach 20% gross margin (below Amazon worst public gross margin), where they will end up. This assumes what I mentioned above, which is the pessimistic view that the next year is growth peak. My pessimistic but in my eyes realistic view, JD will continue to fuel this expensive growth until they can’t, and at that point they will be big enough to gain pricing power and improve their margins. My model assumes a declining revenue growth rate after 2018, which is partly to compensate for inaccuracies and risk, but also since it’s impossible to predict the future. In reality, it is very likely they will grow faster or at least maintain growth over a longer period of time, but it is hard to impossible to predict. I prefer a pessimistic but realistic view. We also assume once profitable, they have a tax rate of 24% which matches other large chinese companies. For margins, the tough part, we assume that in 2023 they will start reinforcing their margins, increasing the gross margin 1% per year while maintaining operating margin ie. keep reinvesting profits similar to Amazon. They maintain this margin growth until 2032, at 23% gross margin, which is just above Amazons worst public gross margin (as well as 5% less than Alibaba's CURRENT gross margin). If we assume this we see a net present value of $52,6 per share (scenario A). This gives a 20% upside on the current price in the current situation. If we aim for what Amazon is today, you can look at the much more optimistic view of reaching Amazon's margins by 2032, we see 141% upside with a net present value per share of $106 (scenario B). In my eyes this margin growth is highly unrealistic. A last scenario could be where they struggle to improve gross margins, start increasing their margin in 2022, and at 2025 they reach 18% margin and then fail to increase it further, we see 47% downside @ $23 usd per share (scenario C). All these calculations were made with assuming a discount rate of 8% and permanent maturity of -2%.
These scenarios are all possibilities, and the truth is that JD:s future is very uncertain. It cannot be predicted. What we do see however is that their value hinges on their extremely low gross margins, and how well they can increase it will decide the company's future (and todays value). We can easily predict extreme swings by taking the realistic scenario A, and see what happens if JD would maintain their current growth until 2021 before having growth slow down. We get a fine fine upside of 339% @ $193,5. Even in the less profitable scenario C, if we maintain the current revenue growth we see over 200% upside. This really shows the massive growth JD is seeing, and this is the ground floor. All JD have to do is to improve margins, which is much easier said than done. However I think they will manage, and I love some exposure to the rise of the chinese middle class, which I think is one of the most profitable trends on earth right now, apart from the war on cash.
Submitted March 14, 2018 at 02:11PM by lykosen11 http://ift.tt/2pdQ6gV
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