JD.com Continues to Execute and Remains Cheaply-Valued

JD.com has expanded profit margins, but its stock price isn't reflecting its improvements.
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JD.com  (JD) - Get Report has been on a tear this past year, with its shares up close to 48%, far outperforming the S&P500 ^GSPC (up 9%) and its larger rival Alibaba  (BABA) - Get Report (up 15%). 

This stock’s outperformance has been driven by strong operational improvements and profit margin expansion. Furthermore, right now the stock is still undervalued. Here’s why:

Impressive Q4 2019 Results – Not A One-off

For Q4 2019, JD.com reported that revenue grew 27% year-over-year, while for full-year 2019, it was up 25% compared with 2018. Since 2015, JD.com has grown its net revenues with a compounded annual growth rate of 34%. Put another way, the company has shown very fast underlying revenue growth.

JD.com CEO Richard Liu has for a long time been claiming that JD.com’s profit margins would improve as its economies of scale increased, and indeed, 2019 saw its non-GAAP gross profit margins continue to expand to 14.4%, up 300 basis points from the same period a year ago, and the highest level in the past five years.

Moreover, JD.com’s management declares that notwithstanding significant reinvestment into its logistic services, its fulfillment gross margins (defined as revenue minus costs and fulfillment expenses divided by revenue) ended 2019 at 8.1% compared with 7.3% in 2018.

Also, its non-GAAP net margin reached 1.9%, far outpacing last year’s non-GAAP net margin of 0.7% and again, this was the highest level over the past five years. 

JD.com notes that these profit improvements are being driven by a combination of scale and technology-based efficiencies.

Significant Competitive Advantage

JD.com has a key differentiator: it’s focused on its everyday low prices strategy and this affords it a significant competitive advantage over its peers. 

Whereas other Chinese etailers have targeted the growing Chinese middle class and have been faced with intense competition, JD.com has positioned itself to serve lower-tier Chinese cities.

Furthermore, the tremendous amount of investment JD.com has made over the past few years in building its fulfillment network has helped JD.com outdistance its competitors in China.

What's more, during the coronavirus outbreak, JD.com saw a surge in demand for its products and services, as inactive and infrequent customers have returned to the platform and discovered new features.

JD.com believes that these new customers are likely to remain on the platform long-term, as JD.com has been active in improving their experiences and value gained from the platform.

Valuation – Large Margin of Safety

JD.com has made it clear it is not intent on maximizing its cash flows at present, opting instead to take market share in China’s highly fragmented retail market. 

Having said that, its cash flows from operations have already reached RMB20.5 billion (approximately $3 billion), putting its price at 22x trailing cash flows.

Also, for the year ahead, if we assume that JD.com grows its revenues more conservatively given the significant uncertainty surrounding the coronavirus outbreak -- say somewhere near 20%-22% -- and that its non-GAAP net margin expands just 10 basis points over 2019, this would mean that JD.com’s non-GAAP EPS would reach at least RMB13.82 (approximately $2.00), making its stock trade for just 20x forward earnings per share.

Investment Risks

JD.com's prospects are reliant on its operations continuing to successfully grow at a satisfactory rate. 

If coronavirus concerns were to grow in China once again, there could be an imposition by the government to curb unnecessary product deliveries, impacting JD.com near-term growth rates and weighing on its operating margins.

I believe, however, that this impact would be temporary in nature.

The Bottom Line

JD.com has had a turbulent few years, but its latest results clearly point to strong growth, operational improvements and margin expansion. And the stock remains cheaply valued.