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JD.com, Inc (JD US) Summary

Core Content and Key Points

• Rating and Price Target: The report reiterates a SELL rating with an unchanged 12-month price target of USD 30.00, which is -28% below the current share price of USD 41.51.
• 3Q17 Performance: JD's 3Q17 results showed a surprising gross margin expansion (GPM ex SBC of 15.5%), which is a historic high, but the report warns that 4Q17 margins are likely to compress due to Singles' Day promotions and Alibaba's subsidies.
• Revenue Growth: JD's revenue is expected to grow at a 32% CAGR over the next three years, down from a 60% CAGR previously. The FY17E revenue is CNY 363,639 million, with FY18E and FY19E forecasts at CNY 449,266 million and CNY 517,315 million, respectively.
• Profitability Challenges: Despite the upside in gross margin, the asset-heavy business model and increased operating costs continue to limit profitability. Core net profit is expected to rise to CNY 10,003 million by FY19E.
• FCF and Capex: Free cash flow (FCF) turned negative in 3Q17 due to inventory build-up and capex investment. JD has 405 warehouses with 9 million m² of total space, a 50% YoY increase.
• GMV Changes: JD revised its GMV definition to include high-value orders (CNY 2k to CNY 100k), leading to a 38-44% upward revision in GMV for the last 7 quarters.
• Estimate Changes: The report raised FY17 gross margin forecast and operating profit by 14% and 1% for FY18-19, respectively, due to stronger results and changes in the competitive landscape.
• Valuation: The DCF-based target price of USD 30 is based on a WACC of 9.3%, cost of equity of 10.7%, and a terminal growth rate of 3%. The EV/EBITDA has decreased from 107.9 in FY16A to 52.6 in FY19E.
• Competitive Pressure: JD faces intensifying competition, particularly from Alibaba, which is using aggressive marketing and subsidies to attract merchants. The exodus of 100 general merchants is attributed to this competition, with most being smaller Chinese local brands.
• Apparel Sales: Apparel sales are expected to face headwinds in the next few quarters, potentially affecting JD's commission revenue from third-party (3P) sellers.
• Positive Factors: There is potential for better sales mix towards general merchandise and cooperation with international brands that saw 200% YoY revenue growth during JD's Double 11 promotions.
• Negative Factors: Slower-than-expected gross margin improvement, increased operating costs, and lower GMV per incremental buyer could hurt top-line growth.

Key Financial Metrics

• Revenue Growth: Expected to grow at 40.8% in FY17E, 23.5% in FY18E, and 15.1% in FY19E.
• Gross Margin (ex SBC): Rose to 15.5% in 3Q17, up from 13.6% in 2Q17.
• Operating Margin: Improved to 0.6% in 3Q17, up from -0.4% in 2Q17.
• Net Margin (Non-GAAP): Increased to 2.7% in 3Q17, up from 1.0% in 2Q17.
• ROAE: Improved from -22.8% in FY15A to 9.2% in FY19E.
• ROAA: Increased from 0.9% in FY15A to 5.1% in FY19E.
• FCF Yield: Expected to be 6.4% in FY17E and 1.4% in FY19E.
• Cash and Investments: Grew 71% YoY to CNY 48 billion, largely due to the proceeds from JD Finance spin-off.
• Inventory: Increased to CNY 40.0 billion in FY17E, up from CNY 28.9 billion in FY16A.
• Capex: Increased to CNY 4.4 billion in 3Q17, contributing to the negative FCF.
• Net Debt/Net Cash: Negative in FY17E, indicating net cash position.

Valuation and Metrics

• Core P/E: Decreased from 187.4 in FY16A to 42.7 in FY19E.
• P/BV: Decreased from 12.3 in FY15A to 7.3 in FY19E.
• EV/EBITDA: Decreased from 107.9 in FY16A to 52.6 in FY19E.
• Net Gearing: Remains net cash in FY17E and FY19E.
• Net Dividend Yield: Remains at 0.0% across all periods.
• Pretax Profit Margin: Improved from nm in FY15A to 0.9% in FY19E.

Price Drivers

• Historical Share Price Trend: JD's share price peaked after solid 2Q15 results but fell afterward.
• Seasonal Sales Surge: Supported 4Q14 results and enhanced stock sentiment.
• China Liquidity Rally: Boosted stock price.
• Economic Concerns: Raised consumption risk and stock pressure after reaching a historical peak.
• GMV Growth: JD posted the lowest GMV growth in history in 1Q16, with 3P GMV growth decelerating from 103% in 4Q15 to 63% in 1Q16.
• Walmart Investment: Announced investment in JD, which could be a positive catalyst.
• JD Finance Spin-off: Provided CNY 12 billion in proceeds, contributing to the cash growth.

Swing Factors

Upside

• Better Sales Mix: Toward general merchandise and other non-3C products.
• Market Share Gains: If JD gains more market share from offline companies and relative to Alibaba.
• Cooperation with Internet Companies: Could drive more traffic to JD.

Downside

• Slower Gross Margin Improvement: In 3C business.
• Higher Operating Costs: Delaying profit turnaround due to penetration of lower tier markets.
• Lower GMV per Buyer: Poses pressure on top-line growth.

Summary of Financial Highlights

Conclusion

JD.com is facing intensifying competition from Alibaba, particularly in the Singles' Day promotions and subsidies. While 3Q17 results showed positive margin expansion, the report warns of potential margin compression in 4Q17. The asset-heavy model and high operating costs continue to challenge profitability, and the FCF is expected to remain negative due to inventory and capex investments. The core net profit is expected to increase significantly by FY19E, but profitability remains a concern. The DCF-based target price of USD 30 is unchanged, and the rating remains SELL due to the uncertainty surrounding future margins and competitive pressures.