Summary
- JD reported mediocre results with JD Logistics also being profitable this quarter.
- While JD is also feeling short-to-mid-term headwinds, I am still confident about the long-term growth potential.
- And even when assuming rather cautious growth assumptions, JD is still undervalued in my opinion.
In the past I published two bullish articles on JD.com, Inc. ( JD ) and while I implied in my first article that the stock might be 41% undervalued I called JD a rare buying opportunity in the second article . And while I was bullish about the company (and the stock), the market mocked me, and the stock continued to decline. Since my first article, JD declined about 25%. For my relief I must point out that not only JD declined, but the U.S. stock market declined about 16% in the same timeframe (the S&P 500 ( SPY ) and many other Chinese technology companies - like Alibaba Group Holding Limited ( BABA ) or Tencent Holdings Limited ( OTCPK:TCEHY ) - lost value as well.
And although I still see a huge risk of a global meltdown with stock markets declining extremely low, I see several Chinese technology companies as already fairly valued (or even a bargain) - including JD. I am aware of the dangers of investing right before a global recession, but I believe JD is one of the picks that should hold a top spot on every watchlist right now.
Quarterly Results
JD reported solid second quarter results for fiscal 2022 with the top and bottom line growing. However, we are clearly seeing growth rates slowing down - similar to many other Chinese technology businesses. In Q2/22, JD increased revenue by 5.4% year-over-year from RMB 253.8 billion in the same quarter last year to RMB 267.6 billion this quarter. Income from operations increased from RMB 301 million in the same quarter last year to RMB 3,758 million - an increase of 1,149%. And finally, diluted net income per share also increased 448% from RMB 0.25 in Q2/21 to RMB 1.37 in Q2/22. Free cash flow also increased slightly from RMB 29,522 million to RMB 30,009 million - resulting in an 1.6% YoY increase.
When looking at the two different revenue streams, net product revenues increased slightly from RMB 219,690 million in Q2/21 to RMB 226,020 million in Q2/22 - an increase of 2.9% YoY. And net service revenues increased from RMB 34,110 million in the same quarter last year to RMB 41,580 million this quarter - resulting in 21.9% YoY growth.
When looking at the different segments, the biggest part of revenue is still stemming from JD Retail. And revenue increased slightly from RMB 232,557 million in the same quarter last year to RMB 241,557 million this quarter (3.9% YoY growth). JD Logistics increased revenue 20.0% YoY from RMB 26,061 million to RMB 31,272 million. And finally, Dada generated RMB 2,281 million in revenue this quarter. Dada was acquired in the first half of 2022 and the company is a local on-demand delivery and retail platform in China. It is operating JDDJ, one of the largest on-demand retail platforms for retailers and brand owners in China.
The biggest part of operating income is stemming from JD Retail, which reported RMB 8,173 million in operating income (an increase of 36.5% year-over-year). Aside from JD Retail, JD Logistics also became profitable this quarter and reported an operating income of RMB 36 million this quarter (compared to an operating loss of RMB 356 million in the same quarter last year). Dada was still not profitable and generated an operating loss of RMB 424 million.
And finally, annual active customer accounts increased by 9.2% to 580.8 million in the twelve months ended June 30, 2022.
618 Shopping Event
JD.com is certainly struggling. But that is not surprising as not only JD.com is struggling - most other major Chinese technology companies including competitors like Alibaba or Tencent (which is not a direct competitor) are struggling as well. And in other countries we are seeing strong signs for retail sales slowing down as well.
In case of JD, we can look at its annual 618 Shopping Event (an event that was started in 2004 on the day JD was founded - June 18th, 1998). According to Reuters , total sales for JD rose 10.3% over the 18 days leading up to June 18th. And while double-digit growth is still impressive, it is sharply down from 27.7% growth in the previous year. And not only JD is seeing headwinds: Alibaba and its Singles Day in November (the biggest shopping festival in China) also saw sales just growing 8.5% last year.
Accenture ( ACN ) is also giving some reasons for the growth slowdown in its " Accenture Chinese Consumer Insights 2022 " report:
As uncertainties rise, people are more inclined to scrutinize their consumer spending. As shown in Figure 14, in a survey of Chinese consumers in June 2021, close to 40% of the respondents did not take part in the 618 Shopping Spree, with the top reason being that they did not want to consume impulsively. Of those who did buy something, over 80% of indicated they had prepared a shopping list in advance, suggesting that they were not simply attracted by low prices but looking for value.
I don't think that events like Amazon's Prime Day, Alibaba's Singles Day or JD's 618 Shopping Event won't work anymore. They stand in a long tradition of similar events like "Black Friday" and "Cyber Monday" which were successful for decades. But the numbers giving us strong hints that growth for retailer will slow down in the quarters to come, and customers won't purchase with the same frequency and intensity as they have in the last few years.
Chinese Consumer: Long-term Growth
While we can't ignore the short-term difficulties, we are rather interested in long-term investing and the long-term growth story and business model of JD seems to be still intact.
We can start by positive long-term trends that will most likely continue in the coming quarters. Since 2010 (as well as in the decades before) the per capita disposable income of urban residents is constantly increasing and between 2010 and 2021 the number more than doubled from below 20,000 yuan per year to more than 45,000 yuan per year. At the same time, the per capita consumption expenditures of urban residents increased as well although we can see a tendency to save a little more: While in 2010, 70% of disposable income were spent, only 64% of disposable income ended up as consumption expenditures of urban residents in 2021.
Another positive trend for JD is the increasing frequency of online shopping. According to the above-mentioned Accenture study, about 44% of respondents stated an increased frequency of online shopping while only 7% decreased the frequency of online shopping (with 49% reporting unchanged frequency of online shopping). This is another positive trend for JD, as the company will - without much doubt - profit from increasing online shopping.
Long-term Bet on China
In my last article about Alibaba, I already talked about the changing world order (a concept most famously presented by Ray Dalio). And while this hypothesis is similar true for JD.com as is might be true for Alibaba or Tencent, we must point out the speculative nature of the following arguments (hence hypothesis).
In my last article about Alibaba , I wrote:
Dalio argues (see short version here ) that these shifts happen when the dominant power (right now, the United States of America) is not only confronted with an increasing external conflict (like the trade war between the United States and China) but also with increasing internal conflicts (like rising populism and polarization) as well as interest rates being zero and large amounts of money being "printed" by the central bank.
And it is definitely a plausible scenario right now that the United States might be struggling in the decades to come, while China might become the dominant economic power again. And if China should become the dominating power in the world, this would not just fuel growth in China, but would also make it easier for companies like Alibaba to grow internationally. Typically, the dominant power was able to expand abroad, and Chinese companies might become dominant in a similar way as American companies became dominant in the 20th century.
And even when the macro bet - China becoming the dominant economic power in the world - is correct, identifying the companies that will thrive long-term is another difficult step. Hence, we should not bet on a single company but try to identify several companies that might be long-term winners and to diversify over several businesses. In my case I would assume betting on Chinese technology companies with a leading position not only in China but also worldwide would be a good starting point: This includes the already mentioned companies Alibaba, Tencent and JD but also Baidu Inc. ( BIDU ).
When talking about macroeconomics and politics, we also should keep in mind that tensions are increasing. Aside from the ongoing currency and trade war between the United States and China as well as the hot war between Ukraine and Russia, many different scenarios are plausible in the coming years: other countries could enter the war or Russia could expand the war by attacking other countries aside from the Ukraine.
And as investors we also must look at potential capital restrictions. It could very well happen that European investors (that would affect me) as well as American investors (that would affect most of you) are not allowed to invest in the Chinese market for some time. Of course, JD is listed on Nasdaq making it unlikely that European investors (and especially American investors) will not be able to invest in the stock (buy and sell). But the delisting of Chinese stocks on U.S. stock exchanges is still a risk that should be taken serious, and it could suddenly not be able to European or American investors to buy and sell the assets anymore.
Intrinsic Value Calculation
When trying to determine if JD is a solid investment, we can start by looking at the valuation multiples JD is currently trading for. And when looking at the price to free cash flow ratio - the best and most important among the simple valuation metrics - we see JD trading for 25 times free cash flow. The lowest P/FCF ratio was 23.88. But on an absolute level, a P/FCF ratio of 26 is not extremely cheap.
Instead of looking at simple valuation metrics, we can also try to calculate an intrinsic value by using a discount cash flow calculation. I will calculate an intrinsic value for the stock listed on the Nasdaq. As basis we use the free cash flow of fiscal 2021, which was RMB 26,278 million (resulting in $4,116 million). For fiscal 2023, we assume the free cash flow will stagnate once again. For the following years until fiscal 2032, we assume 10% growth followed by 6% growth till perpetuity. When using a 10% discount rate and 1,561 million in outstanding shares ( according to JD's stock quote page ) we get an intrinsic value of $79.76 for JD.com.
And of course, we can ask the question if 10% growth is realistic for JD in the years to come or rather overly optimistic. While revenue increased with a CAGR of 29.61% in the last five years, revenue is expected to grow with a CAGR of 11.56% in the next ten years ( according to Seeking Alpha ). While revenue growth will be a major contributor to bottom line growth, we should also expect that margins will improve in the next ten years.
When looking at peers like Alibaba or Pinduoduo ( PDD ), JD certainly has the potential to increase its operating margin. And it doesn't even have to reach 10% or 20%. When JD would be able to report an operating margin in the low-to-mid single digits this would improve the bottom line in a dramatic way. By the way: Analysts are expecting earnings per share to grow with a CAGR of 30% until fiscal 2025.
Conclusion
JD seems to be in line with many other Chinese technology companies - including the major companies like Alibaba or Tencent - as the stock also appears to be deeply undervalued. I don't want to bet on JD (and other Chinese technology companies) to already have reached the bottom. There is still some downside risk. But as a long-term investment I think $50 is not just a fair price but might rather be a bargain.
For further details see:
JD.com: Long-Term Potential Is Overshadowed By Short-Term Slowdown