Vipshop: Does Valuation Matter?

Summary

  • Vipshop has a net cash position equal to c. 45% of their current market cap.
  • This is not “dead cash” as they recently announced a $1B share repurchase program.
  • After balance sheet adjustments, Vipshop trades at >5x earnings for 2022.
  • Vipshop’s fundamental “cheapness” however comes with a catch.
  • I give my take on the situation.

Introduction

You do not find many fair to high quality businesses set for long-term growth, trading at sub 10x earnings in the US or Europe. In contrast, this has become the norm for Chinese stocks and there is no doubt that a large number of Chinese stocks have become cheap on pure numbers – Vipshop being one of them.

What separates the Chinese bulls from the Chinese bears is however not business valuation – it has not been for a long time. If valuations have fallen to a point where every sensible investor can see that they are cheap from a pure business valuation perspective – something else is obviously at play. What is at play is, of course, that a large part of the investor community has lost confidence and trust in China from an investment perspective. This is well known.

The question I ask is then: If these stocks trade at these low multiples primarily due to non-fundamental factors (and have done so for some time), am I not fooling myself making a bull case looking purely at the business fundamentals? Let us assume that I am. The question then is: Do I have conviction that whatever non-fundamental factors that have caused the general China equity market distaste in the first place will vanish or gradually disappear and as a result cause a valuation re-rate from current multiples? Before I continue, let me first shed some light on Vipshop’s fundamental cheapness.

Vipshop’s Business In Short

In short, Vipshop is the leading discount retailer in China, selling apparel cosmetics and home goods products. Vipshop’s sales occur predominantly online and consist primarily of inventory clearance sales. They have grown their revenue with the Chinese e-commerce market in the past, posting a 3-year revenue CAGR of 11% (2018-2021). They have maintained a resilient margin profile and I expect this to be the case going forward – this is in line with management expectations.

Vipshop’s margin profile and quarterly earnings figures

98% of Vipshop’s orders are placed by repeat customers and 32% of their total GMV is generated from their “Super VIP customers” who are highly retentive and generate 8x the revenue of an ordinary customer.

Given Vipshop’s loyal customer base, scale ($28B TTM GMV) and no major structural business change over the past year, I expect Vipshop will continue to feed on the growth of the Chinese e-commerce market. I note that based on today’s Q1 2022 numbers and their Q2 guidance, revenue for H1 2022 will be c. 15-20% lower compared to H1 of 2021. This is primarily a function of the broader Chinese market outlook (which will be volatile from time to time) as well as strong 2021 numbers resulting in tough comps.

Valuation – Fundamentals

The valuation is relatively straightforward and no fancy financial model is needed.

Vipshop has a net cash position of $2.5B. They currently trade at $8.50 or a market cap of $5.7B. Netting out their net cash, we get $3.2B (EV). They just announced a $1B share repurchase program which will run over the next 2 years, so the cash will clearly be used – it is not just sitting on their books.

They generated c. $170mm of net income in Q1. Their revenue expectation for Q2 is just below Q1 and taking into account the seasonal much stronger Q4, simply multiplying Q1’s net income by 4x is conservative as the margin profile for Q1 was in line with recent years average.

That leaves us with c. $680mm of 2022 net income – a number set to grow for years to come. Based on the current value assigned post balance sheet adjustments of $3.2B, we are looking at a meager 4.7x earnings multiple for Vipshop. There is no doubt that this multiple is reality only because Vipshop is a Chinese company.

Is It A Buy Then?

Going back to my introduction: I believe I am fooling myself if I simply look at the fundamental numbers and conclude that this is a bargain. It is my belief that if fundamental numbers are not the main reason for continued depressed share prices, it is not sensible to just look at this parameter and draw a conclusion.

If I had a high degree of conviction that the current sentiment is transitory and that Vipshop and its Chinese peers will regain their previous multiples, this would be a screaming buy.

I conclude that I do not know when the non-fundamental factors that have caused and are causing these depressed valuations will disappear – nobody really knows. As a result, buying into Vipshop and other Chinese stocks is a bet on sentiment shift – a bet that I find speculative.

Valuation, however, does matter – it always does. It matters in the sense that if sentiment truly changes for x reason, the upside will be a result of how cheap these businesses are on a fundamental basis. Vipshop could very well trade at 12x earnings after adjusting for net cash if sentiment truly changes, which would result in upside on current numbers of c. 100%.

Concluding Thoughts

I prefer investments where I am able to build a higher degree of conviction than I can with Vipshop (due to China). It seems obvious to me that you have to draw a conclusion on what has actually caused the general Chinese sell off. Observing that Vipshop and other Chinese stocks are cheaper than they have been historically based on e.g. operating multiples is an observation. An observation however is not enough, you need catalysts. In this case, you need a gradual improvement in sentiment towards Chinese stocks to create a multiple re-rate. I find it challenging to spot catalysts that will cause this sentiment change (I do not know when or if) and I therefore find it challenging to call Vipshop a strong buy even though the business valuation as an isolated factor might indicate that.

Could sentiment change to a certain extent and result in material upside? Yes. Do I have the slightest idea of when/if this will happen? No.

Author: LBMF Invest, Seeking Alpha

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