Vipshop Holdings Is An Ok Business, But That Might Not Be Enough

Summary

• Most analysts see VIPS stock as fundamentally undervalued, but fundamentals can quickly change.
• I feel using 2020 for a valuation basis is wrong as many brands had excess inventories to dump and Vipshop is a perfect fit for that.
• Even if VIPS stock would reach my fair price, I would still not buy it as I prefer better quality businesses.

Vipshop (VIPS) stock analysis is part of my full analysis of the Chinese E-commerce sector which is an extraordinarily complex environment and therefore you must be careful about where you put your money. There are opportunities, but also big risks to better avoid, no matter the upside.

I will discuss the stock price, give a quick business model overview discussing factors easily overlooked by investors but extremely important, make a valuation and conclude with an investment conclusion.

VIPS Stock Price Overview

VIPS stock has been around for a while now and early investors did well. But after the post IPO boom, things have been extremely volatile and remain so.

Source – Google Finance, Vipshop stock price historical chart

VIPS stock enjoys periods of extreme exuberance, like it was the case from 2012 to 2015 or 2019 to just recently, but that exuberance often quickly reverts.

As I am writing this, VIPS stock is down 58% from its March 2021 peak. The last decline started in March when investment banks unwinded Archegos leveraged positions and even after that, the stock continued to slide despite the announced $500 million buyback.

Here you can check my video on the total return swap structure Archegos had and what forced the sale and VIPS stock price to crash.

Source – Google Finance, VIPS stock price crash

I made an analysis of VIPS in September 2018 describing it as a potential value stock and the stock is up 202% since, but we need to see what the risk and reward is now to estimate the investing potential of VIPS stock.

Let us first look at the business model which I think is key when it comes to considering investing in Vipshop stock.

Vipshop Stock Analysis – The Business Model

Vipshop Holdings is an online discount retailer for brands in China where the company sells products through flash sales on its vipshop.com, vip.com and lefeng.com websites. As the Chinese discount retail market is not developed, Vipshop is there to do the job online.

Vipshop stock analysis – discount market in China – Source: Vipshop Investor Presentation

The company has created an interesting position for itself where it sells excess inventory for brands at discounted prices.

Vipshop stock analysis – discount market in China – Source: Vipshop Investor Presentation

I remember that things were not looking good for Vipshop back in September of 2018 because revenue growth had been slowing down alongside contracting margins. 2018 and 2019 saw revenue growth of just 10% but there has been a post-Covid boom of 51% growth. Of course, given the lock-downs, many brands must have had excess inventory so online sales were maybe the only option.

Vipshop stock analysis – revenue growth – Source: Vipshop Investor Presentation

The issue with Vipshop’s business models is that gross margins keep declining despite the company showing remarkable revenue growth.

Vipshop stock analysis – revenue growth – Source: Vipshop Investor Presentation

There have been two successful bumps in gross margins over the 4th quarters in 2019 and 2020, but 2021 is seeing lower margins already. Plus, the management guided for a significant slowdown in sales for 2021.

In order to sell more, both marketing and administrative expenses have been going up in relation to revenue while fulfillment expenses fortunately declined thanks to scale.

Vipshop stock analysis – cost increases – Source: Vipshop Investor Presentation

When I look at Vipshop’s business model, it is after all a retail business selling discounted items which means the whole game is based on price, thus low margins. Thanks to scale, Vipshop manages to keep margins positive, but that can change at any time given its dependency on marketing activities on partner platforms like Alibaba.

Vipshop net margin – Source: Vipshop Investor Presentation

In Q1 2021 revenues grew 51% as the company must have gotten tons of inventory that retailers did not manage to sell around the world due to lockdowns. However, to sell all excess inventories, marketing expenses increased from 412 million RMB to 1.3 billion RMB. As Alibaba makes most of its money by selling search results to retailers, we know where the money went. This also means that a company like Vipshop is at the mercy of partners like Alibaba.

Vipshop’s dependence on Alibaba – Source: Vipshop Investor Presentation

In Q1 2021, Vipshop’s partners made 1.3 billion RMB on Vipshop’s marketing expenses while Vipshop’s net profit was 1.5 billion RMB. This is still a good result, but it is also indicative of the key weakness in Vipshop’s business model. As brands manage to sell more through their own channels, VIPS’s inventory might be of lower quality, or the company might have to accept lower margins or see Alibaba take more money.

I would not describe VIPS as a great business, but just as an ok business doing its job in an extremely competitive environment. From an investing perspective, this means you cannot know what the business will look like 5 or 10 years down the road. There is an increased risk when it comes to investing as the investing scenarios can be many. U.S. Bureau of Labor statistics show that only 21% of companies make it to their 20th anniversary and we do not have the data, but things in China might be even worse.

Therefore, before investing in VIPS stock one must keep in mind the key business risk because if at some point revenues do not grow anymore and margins decline for whatever reason, maybe even for a year or two, the market will not like it and the stock might suffer badly like it had been the case from 2015 to 2018.

In order to prevent a negative outcome, one should invest with a margin of safety. Let us look at the financials and make a valuation to see what the risk and reward is.

VIPS Stock Fundamentals and Financials

Vipshop delivered extreme growth over the last decade but there have been no dividends while the number of shares keeps increasing despite the buybacks done in 2019.

Vipshop’s 10-years financials – Source: Vipshop Morningstar

Earnings per share have gone up to 9.73 RMB per share or $1.5 per share that gives a PE ratio of 12.62 which is extremely low for a fast-growing e-commerce company. But, this also means the market isn’t extremely happy with the outlook even if growth is expected to be between 20% and 25% in the next quarter.

Cash flows look even better than earnings but apart from the announced buyback activity of $500 million (that barely covers the share-based compensation of 671, 688 and 951 million RMB for 2018, 2019 and 2020 respectively) we don’t know what the management’s intention with the money is. I have seen many Chinese companies simply buy stakes in other companies which often destroys shareholder value. An unclear deployment of cash is another risk related to VIPS stock.

The risk is simple, if the company goes back to 2018 margins, earnings per share can quickly decline 50% and then you suddenly have a pe ratio of 25 and if we assume no growth for a period, you get the feeling what will happen to the stock.

VIPS stock valuation

I have made three scenarios for VIPS stock. In the first case scenario I assume earnings per share to be a bit lower in the future as 2020 was a special year for e-commerce. With EPS of $1 and earnings growth of 10% for the next 5 years and 7% after that, while expecting a 10% investment returns and a 12 terminal multiple on earnings, VIPS stock intrinsic value would be just $9.77.

If I expect growth to be 15% over the next 5 years and 10% afterwards with a terminal multiple of 15 2030, then I get to $25 which is still below current levels on pretty exuberant linear estimations.

In my worst case scenario, with slower growth and lower margins, VIPS stock could be fairly valued in the low single digits.

VIPS Stock Valuation – Source: Sven Carlin Research Platform (free template download)

On the upside, even if they keep growing from the current level of $1.5 EPS at 15% per year for the first 5 years and then 10% for the second 5 years, my VIPS stock valuation comes at $25 per share which would give just 25% upside from current levels which is something too risky given the above described risks.

VIPS Stock Investment Conclusion

The above leads to the conclusion that Vipshop is an ok business but that it might be hard to compete with others in the extremely competitive Chinese e-commerce environment.

Vipshop’s market share has been declining over the years – Source: EqualOcean

Vipshop’s number of active users in 2020 was 43 million, which is a pale number compared to Pinduoduo’s or Alibaba’s numbers and therefore it is likely Vipshop will always be a second-tier player.

The risk of being a second-tier player is that you can never reach sustainable profitability as it is likely you need to constantly invest just to keep up with the competition (think of the 5% extra discounts for Super Vip customers).

So, my personal conclusion is that Vipshop is not a good enough business for me to be considered. From a business investing perspective, one could make money swing trading between good and bad periods but the key to understand is the risk and reward. I would not be surprised to see VIPS stock back in the single digits over the years.

From a comprehensive e-commerce perspective, VIPS looks like a business completely dependent on Alibaba where VIPS has an asset heavy model and Alibaba an asset light – the risk and reward is pretty clear. But it is also true Alibaba will keep VIPS alive for as long as possible, so that keeps in a swing trade on momentum, nothing more – just don’t end up like Archegos.

Author: Sven Carlin, Seeking Alpha