Updated Thoughts on JD.com ($JD)
I recently wrote a Twitter thread about the investment case for JD.com. I’ve been a JD bull for some time, and I think it continues to be attractive. This will be a short post, but I wanted to add some more color outside of the 280-charater limits on Twitter.
Margins
I spent a lot of time on JD’s LT margin profile in the Twitter thread, so I’m not going to repeat myself — please go read that first. Tl;dr is that I think management’s LT margin guide of HSD net margin is quite reasonable, and maybe actually conservative.
So what does this mean? Given Retail’s EBIT margin is currently ~4%, this means that EBIT should grow materially faster than revenues as margins expand over time.
Growth
Growth is, I think, the much harder thing to predict in this situation. It basically boils down to one question: what will JD’s e-commerce market share be in 10 years?
It’s no secret that China retail will grow over the next decade, probably roughly in line with GDP, maybe a bit faster. It’s also no secret that online penetration will continue to march higher. So we know that China’s e-com market size will be much larger ten years from now than it is today. Nobody knows exactly how much bigger, but going off of the assumption that retail spend grows in line with GDP, we get RMB 70tn in retail spend, and assuming 50% online penetration (up from ~25% right now), we get RMB 35tn in e-commerce spend. Let’s go with those assumptions for now.
So how much of that 35tn pie does JD get? JD’s current e-com share is ~20%, so as a lazy shortcut, in my Twitter thread, I just went off the assumption that they maintain that share and end up with RMB 7tn in GMV in 2030.
Obviously, it’s more complicated than that for two reasons: 1) the categories that go online in the next 10 years will be very different than the ones that went online in the last 10 years, and 2) Chinese e-com is hyper-competitive — PDD, Bilibili, Bytedance, Kuaishou, Tencent and others will all be looking to take share from BABA/JD in the future.
Starting with the first point: electronics, home appliances, and apparel were among the first categories to go online, and their online penetration rates are quite high. While penetration in those categories will probably continue to increase marginally, the bulk of the growth will come from categories like fresh (<20% online penetration today) and FMCG, which are much less penetrated. JD’s ability to maintain (or grow) market share will be predicated on its ability to win in those categories.
As in pertains to those categories, and grocery in particular, bulls would say that JD has positioned itself as a supply chain company first — JD’s strength has always been logistics & supply chain, in contrast to PDD, for example, which is stronger on UI/social. And the hardest part of grocery is supply chain. New initiatives like community group buying have gotten a lot of attention, they would say, but even for those players, good supply chain will be critical and JD is best positioned. JD’s strategic investment is Xingsheng is an example of this. They would also argue that general merchandise and FMCG have been JD’s areas of focus for a while, and the growth rates continue to look solid.
Bears, on the other hand, would say that JD is clearly missing out vs. PDD and Meituan on community group buying, and that it has failed to meaningfully expand outside of 3C’s into other focus categories, like apparel.
The other “category” that is going to come online in the next 10 years is customers from lower-tier cities, and similar arguments on both sides can be used about JD’s chances of success here. Bulls would point out that in the most recent quarter, 80% of JD’s new users were from lower-tier cities (Taobao is similar) as evidence of JD’s progress on these consumers. Bulls would also cite JD’s stronghold on wealthier customers in tier 1 and 2 cities as a strength — as lower tier customers “upgrade” and become more like their T1/T2 counterparts, they will naturally shift to JD. Bears would argue that JD (and BABA) have failed to put any dent in PDD’s growth, and that PDD is masterful at acquiring and retaining lower-tier customers through social/gamification, and will retain those customers as they upgrade. Furthermore, PDD seems to be making some inroads into T1/T2 cities and even some 3C categories.
Similar arguments can be made regarding competition from newer entrants — primarily social media players. Bears would say that JD is not a “social” company, and will lose on this new wave. On the other hand, the social companies still need supply chain & backend expertise, as JD’s Kuaishou partnership illustrates.
What does it all mean?
The truth is, I don’t know exactly how it will play out. 10 years is a long time, and the outcome will be determined largely by how well each player executes. JD’s team is good — but so are all the other players — so it’s hard to tell. What I like best about JD is there is a margin of safety — even if their market share drops, the industry tailwinds should power some level of growth and margin expansion, and you’re unlikely to face permanent impairment of capital. If JD’s market share holds or grows, you win big. I’ll run some numbers to illustrate:
Let’s say JD’s market share halves to 10% in 2030. That is RMB 3.5tn in GMV, which going through the margin math, translates to $15bn in EBIT. At 10x EBIT, retail would be worth $150bn, and with other investments and generated FCF included, the total value would probably be $200bn+, versus today’s market cap of ~$150bn. In other words, tails you win a little.
You might argue that the long term margins I’ve laid out are not possible on only RMB 3.5tn in GMV. There is some truth to this on the gross margin/fulfillment expense side, but if JD truly became such a slow-growth business, it would be reasonable to justify axing marketing expense, which is 4% of revenue, and cutting R&D and G&A significantly too. This alone would bring retail’s EBIT margin from 4% to 8%ish, which along with some gross margin scale should still make HSD net possible if the company is run purely for cash.
Let me also just emphasize how unlikely this bear scenario is. JD’s current run-rate GMV is ~RMB 2.5tn, and at the current growth rate, JD would hit RMB 3.5tn in GMV within 2 years. This bear case assumes that JD’s GMV doesn’t grow from there for another 8 years — despite it being leveraged to one of the clearest growth stories in the world, which is Chinese e-commerce. Objectively, I think that is quite unlikely.
As I highlighted on Twitter, in the base and bull case, the outcome is much better.
Heads, you win big. Tails, you win a little.
P.S. JD is an incredibly resilient business. In the early years, they fought (and won) brutal price wars with Newegg and Dangdang. Then, they dealt with BABA pushing exclusivity agreements with their merchants, and their founder being accused of rape. In 2018, the stock was down 50% as a result. Through it all, JD chugged along — not just growing core Retail, but creating ancillary businesses like Health, Logistics, and Digits. I see PDD/lower tier cities/grocery as just the latest in a long line of challenges that JD has successfully dealt with.
P.P.S. Offline and online are converging - both BABA and JD have increasingly moved in to physical retail to complement their online offering, just like Amazon has done in the West. So depending on what % of offline spend JD manages to capture, it is possible that there is some degree of TAM unlock that this analysis misses.