Preface
Since my article last month about why it was time to sell Square (NASDAQ:SQ) attracted quite a few heated responses, I would like to preface this article with the following note: unless otherwise indicated, my recommendations are not intended to predict day-to-day actions. My approach to investing has always been long-term value/growth. I try to compare the market value of a company with my own assessment and make my investment decisions that way. So as always, please use your own discretion when trading.
That being said, I"d like to share with you the reasons why JD.com(NASDAQ:JD) is my current top holding, and then address some of the most common concerns investors may have.
Reason #1: Sound Management
Source: Twitter
JD"s founder and CEO, Richard Liu, reminds me a lot of Jeff Bezos and Steve Jobs. He is determined, bold, and persistent. His company, named after his own name (D stands for Dong, which is part of Liu"s first name), is entrenched in his personal vision and belief. Many already know and have compared JD with Amazon, due to JD"s similar operational strategies such as having its own logistics department and its automated warehouses. However, I think the most striking similarity lies within the two founders. Like Bezos, Liu focuses heavily on the future of the company, as opposed to near-term profits. He reiterated this point in his latest earning"s call:
over the long-term, our commitment is to improve our profitability on an annual basis. And with that in mind, we do not manage earnings on a quarterly basis, and if any certain quarter has outsized profitability, we may decide to reinvest part of that excess return back into the business to pursue further growth. So that strategy has not changed. [...] so if you look at it over the long-term, any excess return beyond our expectations will be reinvested roughly 30% to 40% of those excess returns back into the business and half of that will be in technologies.
- Richard Liu, 2017 Q3 earnings call
Under Liu"s leadership, JD has become one of the most ethical and trusted companies in China. It is known for never selling counterfeit products, and its deliveries are fast and reliable. Most recently, JD announced a Blockchain Food Safety Alliance with Walmart, IBM and Tsinghua University, in an effort to bring safer food supply to China, a huge need for the Chinese.
Reason #2: Robust Growth
JD"s upside comes from its tremendous growth potential.
There are currently only 4 large-cap companies in the current market that are top 20% in all of the following categories:
3-5 Yrs Foward EPS
Rev Growth (TTM vs Prior TTM)
Rev Growth (past 5 Yrs)
Book Value Growth (past 5 Yrs)
Source: Fidelity (account required)
As one can see, JD is part of an elite group of growth companies. While past performances are not always indications of future, it does show what JD has been capable of doing. In addition, the ever-growing Chinese E-commerce market will certainly help JD"s case. The Chinese online retail market share is expected to continue its vigorous rise.
Source: Statista
Reason #3: Cheap Valuation
For a company with such positive outlook, the current valuation is cheap in my opinion. JD"s next year"s P/E is estimated to be 47.9, which is neither cheap nor expensive for an emerging growth company. However, the Price/Sale Ratio, one that more accurately reflects the value of a company that doesn"t focus on earnings, is only at 1.25, which is ridiculously low. In comparison, Amazon (NASDAQ:AMZN) and BABA (NASDAQ:BABA)"s P/S ratios are at 3.47 and 15.34, respectively. Should JD continue its growth and improve its margin (more on this below) as expected, I expect P/S to match up more closely to its peers. Additionally, JD"s price/book ratio is also the lowest of the three.
Source: Fidelity (account required)
Reason #4: Strong and constant partnerships
As many already know, China"s tech giant Tencent currently owns 21.25% stake in JD, one that surpasses its CEO, who owns only 16.2% (Liu still owns 80% of the voting power). As a result, JD gets access to the huge Wechat user base. On Oct 20 this year, JD and Tencent launched JD-Tencent Retail Marketing Solution, which provides a better understanding of Chinese consumers for both JD and Tencent. I expect the effect of the project to start surfacing in 2018.
JD"s ambition doesn"t stop with Tencent. I"m not going to list all of their partnerships, but just know that in December alone, they"ve announced the aforementioned Blockchain Food Safety alliance with Walmart and IBM, introduced New York fashion label Derek Lam"s debut, sponsored the Shenzhen Marathon, announced that they will open hundreds of unmanned stores, partnered with the accelerator firm Plug and Play, pitched to Canadian PM Justin Trudeau about delivering seafood with drones, and invested in Vipshop with along with Tencent (more on this below.) In short, This is one busy company with endless possibilities.
Reason #5: Good financial health
With a 1.1 Current Ratio (Compared to BABA"s 1.7 and AMZN"s 1.0), JD is capable of paying down its debts. it currently has an investment-grade of Baa3 rating from Moody"s, and a BBB from S&P. Both firms also revised the outlook for JD from "Stable" to "Positive" as well.
Concern #1: Profitability and Profit Margin
Income Statement, standardized by S&Q Capital IQ.
Source: Fidelity (account required)
Unlike Amazon in its early days, JD actually posted their first profit in May this year, proving to the world that they are able to profit while growing their business. Nonetheless, One legitimate concern that many investors have is the thin profit margin. Its net profit margin for the most recent quarter is merely 1.23%. A company can have huge revenue, but without a healthy profit margin, it won"t be attractive to investors. To that concern, Liu emphatically made a promise to the investors in the latest earnings call:
I can promise you that net margin would increase every year. [...] If you look at our promises in the past 10-plus years, all of our promises would always realize in the end.
- Richard Liu, 2017 Q3 earnings call
Whether you believe him is up to you. But CEOs, especially one like Liu, generally do not make promises in such absolute terms unless he believes that it will 100% come true. Falling short on such a promise would be extremely discouraging to investors and hurts their confidence in the company. JD"s gross margin seems to support Liu"s promise as well, as it has been on a steady increase every year.
(Data extracted from Morningstar)
For what it"s worth, JD is actually doing better than Amazon"s early days, as Amazon had consistently operated at a loss.
Source: Fundable.com
Also, a big part of JD"s operating expenses comes from the traffic acquisition cost (the fees JD pays to partner websites to run its ads or services). That is something I believe can be reduced in the future.
Concern #2: Competition
Despite having two completely different business models, Alibaba is still considered to be JD"s #1 competitor, which has some people worried about the potential risks of BABA dominating market shares. However, a Stifel analyst, who recently resumed coverage of JD with a "buy" rating, noted that there is room for both companies in China"s huge e-commerce market.
One weakness JD had was its apparel business, as they were "only one-third to one-fifth of their major competitors", according to Liu on their Q3 earnings call. However, that changed when they partnered with one of the largest online retailer in China, Vipshop on Dec 18.(NYSE:VIPS) Vipshop"s main strength is its apparel business, which compliments JD where it lacked the most. I think this move makes a lot of sense for JD, who needed to attract more female customers.
Other Concerns?
As JD is my favorite stock right now, I can be biased when trying to build a bear case. So please let me know in the comment if you have any other concerns regarding the stock, and I will try to address them. Please note that broader market concerns such as North Korea - US relationship, US dollar vs Chinese Yuan strength, etc, while certainly worth considering, generally do not fall into my consideration, as I try not to speculate on macroeconomics and limit my research to company-specifics.
Conclusion
Given its combination of growth, value, and health, JD is a rare opportunity in today"s market, especially for those who missed the boat on Amazon in the early 2000s. The growth path is clear, the upside is huge while the downside is extremely limited. I rate JD as a strong buy, with a price target of $70 (using 2.0 forward P/S, $100 billion Market Cap.)
Disclosure: I am/we are long JD, FB.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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