2023-12-18 20:32:51 ET
Summary
- China and Hang Seng stocks have been struggling due to the ailing property sector and decreased consumer confidence.
- JD's latest earnings quarter shows potential for a bottoming process and a chance for the stock to advance.
- JD's founder acknowledges the need for change in the face of competition and the company's razor-thin margins.
Context & Background Information
China and Hang Seng stocks have been mired in deep malaise for much of 2023, and there have been few survivors of this year's enduring bear market for China ADRs and H-Shares. At the root of the problem for most companies inside Hang Seng is the fact that the ailing property sector in mainland China has deeply dented consumer confidence to a degree that investors have largely de-rated the e-commerce sector's valuation in a structural manner.
Outside of a few bright spots within China stocks such as PDD Holdings ( PDD ) and New Oriental (EDU), most companies in this year's environment have been unable to grow gross margins or guide concretely on further EBITDA expansion. This subdued outlook for most companies within the Hang Seng (to which JD is an important component) has kept a lid on any advance and has resulted in most rallies being sold and selloffs gaining momentum.
That being said, JD's latest earnings quarter - while not perfect - offers a window of opportunity where investors may consider that at long last the stock (along with the rest of China's ECOM sector constituents Alibaba and Meituan) has seen the final leg lower and may enter the first stages of a choppy bottoming process.
My primary view for JD is that if the recent 24/share level lows can hold, the company has a first-stage advance opportunity to revisit the neckline technical structure of 33-34/share at some point in 2024. The 24/share level is a critical line in sand and it is my belief that multiple daily closes beneath this level will result in the market searching for lower lows.
JD Technical Market Structure (YCharts)
The Catalysts for JD and Fundamental Outlook
One of the most important events for JD in the recent few weeks is that founder Richard Liu discussed that the company has become bloated and must seek change in the face of Pinduoduo's rise. Mr. Liu has seen his net worth cut in half from $10 billion to $4.9 billion as its H-Shares (HK-9618) have fallen by a dramatic 55% in 2023. China's economic slump has forced all e-commerce players to fight for consumers who are now more price-conscious than ever, but despite JD's razor-thin margins after discounting, its price cuts still haven't been perceived as enough to woo shoppers.
In this past quarter, revenues rose a better-than-expected 1.7% to $34 billion from a year ago, while net income rose 32% to $1.1 billion. These figures mostly beat expectations as JD's lower first-party business sourcing costs allowed it to marginally increase profitability due to its operations. In the years between 2017 and 2022, JD grew revenue at a 24-25% compounded annual growth rate and its latest year growth figures of low single digits have caused a very large reset in the stock.
Many Sell Side Analysts on the Street believe that the forward outlook for revenue can achieve 4-5% given the structurally changed landscape for consumer behavior and spending. The positive news is that management guided gross merchandise volume and its supermarket category growth to be above that of retail sales of consumer goods in China.
As of now, JD's business model is characterized by the following segments:
- JD Retail: 89% of total revenue (online direct sales, marketplace, advertising)
- JD Logistics: 13.1% (internal and external logistics business)
- Dada: .8% (local on-demand delivery and retail platform in China)
- New Business: 2.1% (JD Property, Jingxi, and other tech initiatives)
Given that much of the slowdown in JD's retail business has greatly and adversely impacted their forward outlook, multiple valuation metrics reflect this with their EV/EBITDA multiple and forward P/E multiples approaching multi-year troughs.
JD's forward earnings multiple of 9.1X is highly similar to that of BABA, which trades at 8X. The company's valuation has been structurally de-rated due to its poor fundamental performance but an upward revision in its outlook later in 2024 can lift its valuation and stock off current lows.
Risks, thoughts on Entry & Valuation
Although China stocks have a history of trading on sentiment and domestic political affairs surrounding investor perception towards government regulation, we can also witness that the company's stocks also broadly follow its fundamental trajectory.
In JD's case, we saw a 25% revenue growth profile from 2017 to 2022 shrink to a 2-4% single-digit growth story this year in 2023 with 4-5% growth being the base case outlook in 2024. This collapse in top line growth has essentially reclassified the company from being a growth stock to a value stock based on its fundamental characteristics and valuation multiples now clearly reflecting it.
Due to China's structural slowdown in consumer spending, Analysts have continued to cut revenue estimates for the forward two years, which has kept a fundamental cap on any share price gains. This fundamental understanding of its business explains why rallies are sold and selloffs worsen as investors need to see profitability or margin expansion before treating the stock as an investment rather than just a trading vehicle.
That being said, policymakers in China are now looking to reinvigorate its economy with a 5% GDP Growth target in 2024, and that means additional stimulus is likely in play for the coming year to help the property sector find its footing.
If we assume a 5% GDP Growth target for China's macroeconomic landscape and believe that JD can maintain a slightly higher single-digit growth profile at 4-6% per year, the company can see a modest lift off its valuation trough of 4.3X EV/EBITDA and 9X Forward P/E to begin a gradual approach towards the technical neckline of 33-34/share later in 2024.
Sentiment surrounding Hang Seng companies is highly fickle, but on an individual company basis, JD's operating model is likely entering a bottoming phase for its growth outlook and that means the stock has fundamentally more upside than downside from here.
Net/net, I think JD falls in the category of a 2:1 risk/reward profile where the company offers about 20% upside potential to its next resistance level relative to 10% downside back to recent lows. Given its volatility, conservative sizing will likely be helpful in allowing investors to hold the name through intensive range expansion.
Investors who think JD has more potential than a 4-6% revenue growth story in 2024 can explore out-of-the-money Call Options at strategic strikes and long duration expirations.
Investors who believe that JD (and its peer BABA) will continue to be mired in an unescapable cycle of structural de-ratings may wish to look at other China names or Pinduoduo during its next corrective cycle.
For now, until there is greater stability in China's property market, it is extremely important to treat China as an opportunistic trading landscape rather than a safe buy-and-hold investment landscape -no matter how cheap the valuation of its stocks becomes.
For further details see:
JD.com: Upside Potential As Long As It Maintains A Single-Digit Growth Profile