I first started looking at JD.com in late 2016 and it became my top investment idea by the start of 2017. Unfortunately I couldn't convince my Fund to buy it (at mid $20s price then) and watched as it soared to ~$50s at the peak never expecting to have the chance to buy it again at bargain prices.
But by the end of 2018 the stock had crashed as low as $19 with the wider stockmarket decline and its founder Richard Liu caught up in rape allegations. At that time the market and my peers renewed their many old and new fears and hates on JD.com. Justifications ran from the classic favourite: 'the company doesn't and probably will never make money' to new opinions: 'Management is terrible, just look at how amoral the Founder is' and retakes on old fears: 'JD will be crushed between competition from Alibaba (BABA) and new competitors like Pinduoduo (PDD)'.
Since I quit my job in late August 2019, I've been finally able to buy JD.com for my personal portfolio and today it is my favourite and largest individual stock/idea position. The key understanding building blocks to my investment in JD.com is:
1) JD.com offers a superior value proposition to Offline
The way to Consumers' hearts is via Cheap Price and Convenience. E-commerce majors like JD.com, BABA and Amazon typically sell products at lower prices, giving better information (peer reviews, product details), superior customer service (return policies, Q&A) and with outstanding convenience (fast delivery). I expect the conversion of Consumers to E-commerce to continue.
JD.com's reputation for price, product authenticity, customer service and fast quality delivery is not only better than most Offline retailers but maybe even better than its Online peers e.g. JD.com enjoys a higher (relative) market share in high end goods and top tier cities.
2) JD.com has superior cost structure to Offline
Back in 2017 I did an opex cost comparison between the largest listed Chinese retailers (supermarkets: Sun Art, Yonghui and whitegoods/electronics: Sunning, Gome) and JD.com. Based on FY16 financials and 1P (direct sales), JD's opex was 13-14% (7-8% logistics and 6% marketing/tech) while supermarket was 17-20% (2% rent, 13-16% store operating costs, 2% wastage) and whitegoods/electronics was ~12% (5% rent, 7% store operating costs). For the Offline Retailers I then added their Rental Income (leasing space to Brands within stores) and used a blended 30% FMCG and 70% Other (electronics, etc) to get a hybrid adjusted opex estimate of 12-13%. In JD's case I added in 3P Income and got an adjusted opex of 6-7%. This means JD's cost structure was superior to comparable Offline Retailer by 5-6%.
I did an alternate check by comparing the blended GPM for Offline Retailers (same 30/70 ratio) vs JD's 1P only GPM which showed JD roughly invested 9% in Price (how much lower JD's GPM was vs blended Offline GPM) and then the GAAP OPM between them which was -3% (JDMall -0.5% vs Offline Blended 2.5%). This also gave the answer: JD's cost structure was roughly 6% lower than Offline. Note this is with inclusion of 3P at the OPM level.
This opex advantage could be as high as 9% today given the greater % of 3P and more efficient logistics from scale (offset by investment into some loss making FMCG categoires0.
3) Retailing growth is self-financed and improves with Scale
Retailers operate on a negative Working Capital cycle. This is because Brands (goods manufacturer) give merchandise to Retailer on credit terms GREATER than the time it takes to sell the product. Using top Chinese listed companies data here, the large supermarkets typically have Accounts Payable Days of 60-90 days (more Fresh goods the lower the days) but Inventory Days of only 20-40 days. For whitegoods/electronics store Accounts Payable Days ranges from 100-180 days while the Inventory Days is only 40-70 days. Of course Customers pay immediately so Accounts Receivable Days is negligible.
Better negotiated terms, the bigger the Retailer. Both price and payment terms get better with scale. Easy to see this played out in the histories of modern retailers like Walmart, Woolworths, as well as Amazon.
JD.com isn't the first to tread this path. It may interest the Reader to know that Amazon only raised $8m from Kleiner Perkins in 1995, $54m in its 1997 IPO and $100m from AOL in 2001. This tiny amount of capital was enough to grow its business to its $260bn annual sales and Trillion $ market cap today...
So it doesn't matter that JD.com e-commerce was making losses in its early days (from -6.6% GAAP OPM in 2011 reducing to -0.5% in 2016). Those absolute amount of losses are insignificant compared to the Sales growth (and future profitability) which rose more than 22x from 2011 to 2018. Brands were effectively bankrolling JD.com's scale growth and Offline retail disruption. JD.com is now the single largest retailer in China and is systematically conquering product verticals one by one e.g. electronics, white-goods, home-wares, etc. Offline retailers are forced to shut stores when the traffic flow/operating efficiency becomes too low AND THOSE STORES DON'T COME BACK. Another important thing to know is that Retailing is extremely fragmented in China so consolidation of buying power like JD.com is even more extreme/effective than in Western Markets.
4) BABA vs JD.com isn't the real story
Yes to the consumer e-commerce seems to be a choice between buying from JD.com vs Taobao or Tmall. And yes they will continue waging wars across product verticals and service lines like apparel, FMCG, luxury etc. But the bigger story here is: JD.com's disruption of Offline.
China retail goods sales is roughly 20% Online and 80% Offline. Within Online JD.com has ~25% and BABA ~60% market share. In reality it matter little who ends up no1 or no2 given the huge long tail of Offline Retailers who will close down in future years. We should see both Online Sales % Total Retail Sales and JD Sales % of Total Retail Sales continue to trend up.
Secondly JD.com is already too big and in too many verticals for BABA to subsidise a price war to kill them. It's already far bigger than any one of BABA's individual marketplace customers and too big a Sales channel for any Brand to ignore (not to mention China is already targeting BABA's anti-competition practices).
Quick comment on PDD: it competes in the ultra low end and maybe group buying segment of the market. I don't think it competes directly with JD.com (more a Taobao competitor) and I'm not even sure yet if PDD can mature beyond its roots. A real competitor to JD.com would need to accumulate buying power and User loyalty in JD.com's key verticals but I don't see that being PDD.
5) JD.com's direct logistics network is a competitive advantage
JD.com's direct ownership of its logistics network allows superior customer service and User loyalty. Additionally, I believe with time and further economies of scale, JD.com can extract more cost efficiency vs the Cainiao and 3rd party logistics model employed by BABA.
The main reason is: JD's logistics network is primarily B2C: they take large deliveries from Brands into warehouses and distribute last mile to Consumers. This is more efficient than Cainiao and partners' (more) C2C model which requires running collection depots + dealing with smaller and odd lot warehousing. It may be hard to see in the numbers because of the opaqueness of looking through both Cainiao and BABA logistic partners' financials (especially since most are on the franchise model).
However we know JD.com has been steadily increasing its logistics efficiency and is now on track to list Logistics separately as a profitable sister company.
Summary
JD.com to me is a very well run business, highly focused on Customer satisfaction and extracting maximum efficiencies within its operations. Because of this, it should continue to take market share from Offline retailers and building its scale moat advantages. As such, I expect to see:
GMV continue to rise. More driven by GMV/User than User growth in future years but overall I think the growth should be in the 20-30% CAGR range for the next 2-3yrs.
Margins continue to improve. GAAP OPM should trend upwards. I estimate a long term low and high GAAP OPM of 3.5% to 7%. It depends on the % sales of 1P vs 3P where I estimate 2-4% for 1P and 1-2% for 3P (as % GMV). The market is often over fixated on quarter to quarter margins (since that's how Sell-side model and tell their story). I think quarterly margins is naturally volatile as JD.com needs to react to market conditions but the general trend should be upwards driven by rising economies of scale efficiencies.
Growth continues to be self-financed. Related to the GMV growth but I expect to see the working capital from JDMall core sustaining fairly large positive free-cashflows.
Valuation wise on today's closing price of $37.7/ADR, I think JD trades on FY20E EV/GMV of 0.24x, a theoretical PE of 17x (JDMall only using mid point GAAP NPM ~4%). Other than this, their stakes in JDLogistics, JDFinance, Other Investments and Cash probably adds another $10-15/ADR in value.
On my estimates fair value for JD.com assuming 20-25x core JDMall FY20E theoretical GAAP earnings and inclusion $10-15/ADR of Other value is $59-76/ADR or 55-100% upside.
Note also that JD.com current market cap is US$57bn vs BABA at US$552bn despite the much smaller gap in e-commerce market share between the two. Even with Ant Financial and BABA's Cloud business I don't see the relative valuation difference between them as 10x.
Further points:
Deliver what they promise. Management promised to keep raising JDMall margins each year and they've stuck to it even while growing new businesses and verticals.
Capital allocation is generally good. I raised the idea of spinning their logistic properties into REITs all the way back in 2017 and they did it! Similarly they tested Offline supermarkets but didn't go all the way in when they thought they may not win. On the other hand their M&A has generally been value destructive though their deals to get Tencent (and maybe Walmart) as shareholders was very long term positive for JD.com.
Stick to their core competencies. They haven't thrown large amounts of money chasing high growth businesses. They talked about Cloud and AI but you don't see them spend vast amounts on these dreams.
Founder compensation. Richard Liu's 10yr salary (2015-2025) is fixed and composed entirely of 13m worth of ADR options (10% vesting each year) with a strike price of $33.4/ADR. He owns 15.4% of JD.com and his interests are very aligned.
Tencent support. Probably not as important today as when JD.com first started but JD.com remains Tencent's primary e-commerce investment and main battlefront against BABA. As such I expect Tencent to continue supporting JD.com where it can from User traffic to Advertising, etc.
JD Logistics and JD Finance are attractive businesses. The traffic is high quality as it is internal traffic (same rationale as why a department store credit card business is so good) and these businesses should achieve good growth piggybacking off JDMall. Their valuation once listed should reflect that.
The biggest risks to my thesis is the time it takes for JD.com to reach its theoretical profitability level is long and its value creation is never recognised by the market. A parallel could be drawn to Amazon which for many years was considered inferior to Ebay and the market probably only started appreciating Amazon with AWS. Even then it took decades! JD.com could truly end up a long term investment which I'm fine with but which other investors may not accept.
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