- I’ve created simple models that estimate future earnings and stock price potential for two of China’s biggest retailers, JD.com and Alibaba.
- In addition to their potential, we’ll also discuss their risks.
- I recommend checking out yesterday’s article about the Chinese e-commerce market before jumping into today’s.
Yesterday we discussed the Chinese retail environment and discussed what to look for when searching for a good investment.
Today, I’ll dig deeper into specific investments in order to apply my theory. I’ll dig into the biggest Chinese e-commerce players, look at what the real value they offer is at current prices, and look at the risks and rewards at this point in time.
Alibaba (NYSE: BABA)
Alibaba hosted it’s “Singles’ Day” sale on November 11 where it made more than $25 billion in a single day, 24-hour period. While there will certainly be commotion surrounding the positive Singles’ Day sales in China, whatever happened in the past happened and what we have to focus on now is whether or not BABA will make a great future investment.
The first thing to look at is the growth. Revenue growth of 63% is something remarkable and even if it continues at a slower rate in the future, BABA might still continue to shine.
A year-over-year revenue growth rate of 63% for such a large company is simply amazing. This creates an excellent investing opportunity because analysts find it difficult to include such extreme growth numbers into their models because, as an analyst, you try first to be conservative, and second, the growth rates will probably always be volatile and even small changes in the growth rate will have a huge impact on the future stock price, be it positive or negative.
What’s important is that the growth has been strong over all segments where BABA operates which reinforces yesterday’s description of the evolving Chinese retail market.
What I find extremely interesting is the international commerce retail growth of 115%. Perhaps that’s the future that is mostly overlooked by investors and even though it’s a relatively small part of the revenue, it could be the engine that pushes future growth if e-commerce globalizes. The growth rate of 115% shows that there is something there.
The number of active users is in line with what I described in the market overview from yesterday, and is showing strong growth. Further growth could come from rural areas and internationally, especially from India which the company has said is an important market for them.
When a company grows this fast, it’s also important that it is profitable as this shows a healthy business model. BABA shows exactly that.
However, here one must be wary because a lot of BABA’s new businesses are still far from being profitable. Nevertheless, core business profitability allows the company to expand and take advantage of new areas. This is similar to what companies like Google, Facebook, and BABA competitor Amazon have been doing. You never know which one of these new businesses might be the next growth engine in revenues and profits.
Another very important thing is the decline in BABA’s core business EBITDA margins. Given the growth, the decline is inexorable but a point to keep in mind.
If we estimate BABA’s growth to be in line with the average expected Chinese market growth rate of 20% over the next 5 years, its current PE ratio of 52 doesn’t seem high at all.
Trailing earnings per share (EPS) are $3.52. If this grows at a conservative rate of 25% per year, it will get to an EPS of $10.7 over the next 5 years which would imply a PE ratio of 18 in 2022. Given BABA’s scale, it’s possible that earnings will grow even at a faster pace which would keep the valuation high and the stock market returns in-line with the growth.
The best investing strategy with BABA is to go along with the flow while the growth remains strong. Given the strong data I presented yesterday, it’s highly probably that BABA will continue to grow at a healthy rate despite its competition. When the environment starts to inflect, which it eventually will, then it will be time to sell but it’s possible the stock price will be much higher then compared to its current level. The thing is that no one knows when revenues or earnings will start to inflect but since the market is growing at a strong pace, it could be a long ways away.
JD.com (NASDAQ: JD)
JD.com tells a different story than BABA as it’s an upcoming player in the sector and not yet profitable. Revenues are growing at an extreme pace which is excellent.
And what JD offers is one of the best investing situations, a turnaround from an unprofitable to a profitable venture.
However, it’s important to note here that GAAP measures still show a loss, but it seems the market is focusing on non-GAAP measures and thus is excluding share-based compensation, amortization of intangible assets resulting from assets and business acquisitions, revenue from business cooperation arrangements with equity investees, gain on disposals of business, income from non-compete agreement, reconciling items on the share of equity method investments, impairment of goodwill, and intangible assets and investments.
This is an extremely important difference for the long-term investor focused on value creation as focusing on non-GAAP data can paint a different picture because the impairments and amortization of intangible assets are still a cost even they don’t impact current operations.
However as investors, we have to focus on what the market is focusing on in order to play in the same field. Thus, JD’s EPS for Q3 2017 was $0.23 per share.
What’s important is the positive margin expansion which will allow us to calculate a future value as we did with BABA.
If JD continues with similar quarterly earnings and the gross margin continues to expand by 80 basis points per year, we can expect positive developments on the profitability side of things where the stock would earn a different valuation. From the following financial metrics, I’ve derived an estimation where, thanks to JD’s scale and growth expectations, I estimate a 3% long term net profit margin and a conservative 20% growth rate in line with the market.
This leads to an estimation that JD could fetch a valuation similar to BABA which is 50 if it continues to show the healthy growth rates and turns to profitability. For fun, I’ve shown what would happen to JD’s stock price if at some point the revenue growth stalls and the stock receives a fair market valuation which I have marked in yellow in the table below.
It’s also important to understand the risks of investing in such growth companies. Amazon, Facebook, and Google delivered amazing returns because many others didn’t (Barnes & Noble, EBAY), so it’s more about picking the winner here than anything else.
If the situation in China remains as it is now and JD continues on its growth path, the stock price could follow this growth in revenue and earnings. From the plethora of positive collaboration news JD has announced, it’s highly probably that this will happen.
JD’s collaboration announcements:
- JD-Tencent Retail Marketing Solution.
- Strategic partnerships with Baidu, Qihoo 360, NetEase, Sogou, and iQIYI.
- Italian high fashion brand Armani.
- Leveraging these companies’ powerful big data resources, massive user bases, and AI algorithm technologies to strengthen collaboration in precision marketing, user access points, and content marketing.
- JD.com, JD Finance, Central Group, and Provident Capital’s $500 million JV Thailand.
- New Data partnership with 146 Walmart stores and 301 Yonghui stores.
- 160,000 merchants on its online marketplace.
I really wanted to discuss the Chinese retail environment in detail because it’s essential to have exposure to what’s going on there. Many find it unfamiliar and simply don’t look deep enough into the matter to understand the proportions of what’s going on in China.
Nevertheless, there are also risks as any kind of growth slowdown would severely harm the above mentioned stocks, but somehow I see BABA and JD as less risky than the S&P 500 or any distorted asset in the European financial environment. As this article is just my opinion based on simple preliminary research and back of the napkin calculations, please do you own due diligence before making any investment decisions.
As for which one is better, BABA or JD, I think only time will tell because there are so many moving parts that no one could know which will explode and prevail in the end. The fact that the market is so strong and growing so rapidly may make both winners.