JD Could Be 41% Undervalued

Summary

  • JD.com is a Chinese e-commerce company offering mainly retail and logistics products and services.
  • JD is not only growing with a high pace and is a dominant player in China, it also has a great balance sheet with a lot of cash.
  • And even when assuming growth rates slowing down pretty quickly over the next 10 years, JD seems to be deeply undervalued at this point.

September has once again lived up to its name and the last few weeks were not great for the stock market. Many major indices around the world are in a corrective phase right now. And while the major US indices lost only in the mid-single digits, the German DAX lost almost 10% compared to its former high. But this is only a small correction we are seeing in the United States and Europe compared to the situation in China. And especially the Chinese technology companies are deep in bear market territory and in the last few weeks, I started to pay closer attention to some Chinese companies.

Aside from Tencent, which I already covered in November 2018 for the first time, I published articles about AlibabaPinduoduo, and Baidu in the last few weeks. And in the following article, I will look at another Chinese technology company – JD.com, Inc. By market capitalization, we are talking about the 18thbiggest company in China, and we could look at another company which is undervalued and has the potential to grow with a high pace.

Business Description

JD.com is a Chinese e-commerce company, which was formerly called 360buy and changed its name to Jingdong in 2013. The company was founded in 1998 and today the company has close to 400,000 employees. It is also operating and managing more than 23 million square meters of warehouses nationwide and over 9 million self-operated SKUs. Today the company is one of the major B2C online retailers in China and the two major competitors are probably Tmall (which is owned and run by Alibaba) as well as Pinduoduo. It is also worth mentioning, that Tencent is holding about 17% of the shares of JD.

In fiscal 2020, JD generated a total net revenue of RMB 745,802 million. Compared to a revenue of RMB 576,888 million in fiscal 2019, this is resulting in an increase of 29.3% YoY. Operating income in fiscal 2020 was RMB 12,343 million and compared to an operating income of RMB 8,995 million in fiscal 2019, this is an increase of 37.2%. And finally, net income increased from RMB 11,890 million in fiscal 2019 to RMB 49,337 million in fiscal 2020 – an increase of 315%. The reason net income is much higher than operating income is quite simple. The different equity investments of JD – like investments in Yonghui, Dada, JD Digits, Bitauto, Yixin, Tuniu (see note 8 Annual Report 2020) – are contributing to the bottom line. The income statement is also reflecting gains (or losses) from fair value change of long-term investments, gains (or losses) from business and investment disposals or impairment of investments.

(Source: JD Q2/21 Investor Presentation)

Starting with the first quarter of fiscal 2021, JD changed its business structure and today, the company is reporting in three business segments – JD Retail, JD Logistics, and New Businesses.

  • JD Retail mainly consists of online retail as well as an online marketplace and marketing services in China. The company is acquiring products from suppliers and selling them directly to customers (a similar business model as Amazon). As of December 31, 2020, the company sourced products from over 31,000 suppliers and the company had approximately 7.1 billion product reviews generated by its customers as of December 31, 2020. In the second quarter of fiscal 2021, this segment generated RMB 232,557 million in revenue – an increase of 22.7% compared to the same quarter last year. In Q2/21, this segment was the only one profitable and generated an operating income of RMB 5,987 million.
  • JD Logistics is the leading technology-driven supply chain solutions and logistics provider in China. It offers supply chain solutions as well as high-quality logistics services. As of December 31, 2020, JD Logistics operated over 900 warehouses (about 21 million square meters in total). In Q2/21, the segment generated RMB 26,061 million in revenue – an increase of 45.7% compared to the same quarter last year. While the segment was profitable in the same quarter last year, it generated an operating loss of RMB 357 million this quarter.
  • New Businesses mainly includes JD Property, Jingxi, overseas businesses and technology initiatives. JD Property is the infrastructure and asset management segment, which owns, develops, and manages the logistics facilities and other real estate properties. As of December 31, 2020, JD Property managed properties with a total gross floor area of over 12 million square meters. In the second quarter of fiscal 2021, the segment generated RMB 6,963 million in revenue – an increase of 60% compared to the same quarter last year. But the segment was not profitable and generated an operating loss of RMB 3,020 million.

And as long as talking about business segments, we can also mention that JD Cloud & AI businesses were deconsolidated from the company from March 31, 2021, and the operating results are not included in the “New Businesses” segment from the second quarter of fiscal 2021 going forward.

Balance Sheet

JD also has an extremely strong balance sheet with little amounts of debt and a lot of cash and short-term investments that can be used to fuel further growth. As of June 30, 2021, JD had RMB 562 million in short-term debt as well as long-term borrowings of RMB 2,907 million. When comparing the total debt to the total shareholders’ equity of RMB 248.2 billion, we get a debt-equity ratio of 0.01, which is almost not worth mentioning. Additionally, we can compare the total debt to the operating income the company can generate (RMB 7,861 million in the last four quarters) and it would take less than half a year to repay the outstanding debt.

And not only has JD very little debt on its balance sheet. It rather has billions in cash, cash equivalents, and short-term investments on its balance sheet. As of June 30, 2021, JD had RMB 97.3 billion in cash and cash equivalents as well as RMB 75.5 billion in short-term investments. Aside from short-term investments (and current assets), we can look at non-current assets. As of June 30, 2021, JD had RMB 26,367 million in (long-term) investment securities and it also had RMB 66,399 million in “investment in equity investees” (these are the investments, that generated the above-mentioned “other income”).

In my opinion, JD has a great balance sheet, and not only must we not worry about solvency or liquidity, but cash, cash equivalents and short-term investments combined are 27.5% of the current market capitalization of JD (HKD 758.7 billion resulting in RMB 628.3 billion), which is a lot. Or to put it differently, JD has RMB 64.50 in cash, cash equivalents and short-term investments per share.

Impressive Growth

Aside from the impressive balance sheet with little debt and a lot of cash and cash equivalents, JD could also grow with a high pace in the last few years. In the years between 2015 and 2020, JD could grow its revenue with a CAGR of 33% and revenue growth might be slowing down a little bit, but in fiscal 2020 revenue increased still 29% and in Q2/21 revenue increased 26%. JD is differentiating its revenue between net product revenue as well as net service revenue. And while net product revenue increased with a CAGR of 31% in the last five years, net service revenue increased with a CAGR of 48% in the same timeframe.

(Source: JD Q2/21 Investor Presentation)

Of course, we should not only look at the growth rates in the last few years, but also at the expected growth rates for the years to come. Analysts expect that JD will be able to grow with a stable pace in the years to come. According to analysts, revenue will grow with a CAGR of 15.41% in the next ten years (with growth rates being higher in the next few years and then slowing down over time). And for the next five years (until the end of fiscal 2025), analysts assume that earnings per share will increase with a CAGR of 33.7%.

(Source: JD Q2/21 Investor Presentation)

The Chinese retail market is still highly fragmented, with the top 20 retailers having a market share of “only” 17% (in the United States, the top 20 retailers have 52% market share). When looking at these numbers a consolidation is likely in the next few years (or maybe next decade) and as JD is one of the major players in that industry – together with Alibaba and Pinduoduo – I consider the company being one of the profiteers of such a consolidation and it could gain market shares from competitors.

But JD cannot only profit from taking additional market shares. The underlying market is also growing. In the last eight years, the total retail market size in China was growing with a CAGR of 7.8% and is now almost the same size as the U.S. Retail Market. And although growth will slow down, the online retail market size in China (right now RMB 15.1 trillion) is expected to grow with a CAGR of 10% in the years to come.

Intrinsic Value Calculation

One of the last steps in every analysis is looking at the intrinsic value of a stock and comparing that intrinsic value to the current stock price to determine if it could be a good investment. When trying to determine if JD could be a buy at this point or not, we can start by looking at some simple valuation metrics – mainly the price-earnings ratio as well as the price-free-cash-flow ratio. JD is trading for 20.6 times earnings and for 18.9 times free cash flow and considering the fact, that we are dealing with a company, that has the potential to grow with a high pace, these simple valuation multiples seem rather cheap.

Data by YCharts

When looking at the P/E ratio, it declined steeply over the last three years. It was trading for an average P/E ratio of almost 60 during the last three years and three years ago it was trading for a P/E ratio of 200. Now it is trading only at a fraction of that multiple. But considering the fact, that JD is in the phase of turning profitable, the P/E ratio might not be the best metric right now. The better metric might be to look at the price-free-cash-flow ratio, which was 21 on average during the last three years and the stock is therefore trading a bit below the 3-year average right now.

Aside from simple valuation metrics, we can also use a discount cash flow calculation to determine an intrinsic value. As basis for such a calculation, we can use the free cash flow of the last four quarters, which was RMB 26,394 million (in fiscal 2020 it was RMB 30,087 million). We already mentioned above that JD is still growing its revenue close to 30% annually and analysts are expecting earnings per share to grow with a CAGR above 30% in the next few years. However, we are a bit more cautious and will assume 20% growth in fiscal 2021 and then assume growth will slow down over the next 10 years until it can grow only 6% till perpetuity. When calculating with these assumptions (and a 10% discount rate as well as 2,679 million in outstanding shares), we get an intrinsic value of RMB 401.63 for JD. When using current exchange rates, this is resulting in HKD 485 as intrinsic value. At the time of writing, JD is trading for HKD 283, and therefore, the stock is trading almost 42% below its intrinsic value.

Risks

When a stock is trading so far below its intrinsic value, we really must question if we are looking at a true bargain or if we are missing something. In many cases, the explanation for a deeply undervalued stock is wrong growth assumptions and stocks trading for extremely low valuation multiples are often facing troubles.

One reason could be worries if JD will really succeed in this low-margin business. When talking about retailers we usually look at successful companies (survivorship bias) – we look at Walmart’s performance during the past century, we look at Amazon’s performance in the 21st century. But we often seem to forget, that it is not so easy to be successful in this low-margin business. Logistics and retail (even if it is not traditional brick-and-mortar) are capital intensive and JD is also pointing out in its Annual Report:

Because we operate our own fulfillment infrastructure, which requires a large and rapidly growing work force, our cost structure is more vulnerable to labor costs than that of many of our competitors, which may put us at a competitive disadvantage.

However, I like to point out at least two aspects. First, JD is not at the beginning and already invested in its infrastructure and it also demonstrated in the last few quarters, that it can be profitable. In fiscal 2019 and fiscal 2020, the company could generate operating income. Second, with the massive amounts of cash and cash equivalents on its balance sheet, the company can continue to invest if necessary and I am quite confident, that JD will succeed.

A second reason why JD is trading for such low multiple is obvious – and was also mentioned briefly above: JD is another Chinese technology company and as these big Chinese tech companies have been facing immense headwinds from the Chinese government, investors are worried and throwing the stocks out of portfolios. I have already written about this aspect in my articles about Tencent and Alibaba. Both articles were titled “Buy when there is blood in the streets” and my sentiment is obvious. While I don’t want to ignore the risks, I consider the current situation rather a buying opportunity. During the last earnings call, JD also commented on the situation:

Therefore, we believe these policies are not intended to restrict or suppress the Internet and relevant industries, but rather to create a fair and orderly business environment and to promote long-term and sustainable development of these industries.

We believe that the regulatory goals are conducive to JD’s long-term business growth. So far, our business maintained steady growth while committing to best compliance practices.”

But it is interesting, that JD was not hit so hard. Compared to other Chinese technology companies – especially Baidu, Tencent, and Alibaba, we can see, that JD is trading “only” about 35% below its former high, while Tencent is trading 41% lower and Baidu and Alibaba are even trading 55% lower right now.

Data by YCharts

Conclusion

JD is yet another Chinese technology company, that suffered due to the uncertainty that was created by the Chinese government. And while we must face the possibility of growth rates slowing down for JD (maybe also as a consequence of the Chinese government’s actions), I think the stock is deeply undervalued. The current sell-off is generating long-term buying opportunities in my opinion and JD might be a good pick for long-term investors. We are rather talking about short-to-mid-term turmoil and not about real existential threats.

Author: Daniel Schönberger, Seeking Alpha

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