EUR 850.00 For Business Accounts Only

Morningstar | Strong 1Q Result at JD, but Margin May Decline in Following Quarters

We maintain our $36 fair value estimate for no-moat JD after the company released a strong first-quarter result. Our non-GAAP net margin is 0.8% this year, at the low end of full-year guidance of 0.8%-1.2% excluding profit from the property management business, and lower than the 2.7% margin in the first quarter. We expect that management will reinvest the cash flow from the first quarter in the second and fourth quarters' promotion seasons, which could lead to a full-year margin expansion lower than the first quarter. The uncertainty surrounding the recently deteriorating trade dispute between China and the United States and the rapidly changing competitive environment in China could lead to downside. Management stepped away from its margin guidance in the second quarter of 2018 due to the need to increase investment amid strong competition, and we don’t rule out the possibility of a recurrence in the second quarter of 2019. Management has maintained its margin guidance for 2019 and will review it in the next quarter. Strong second-quarter revenue guidance implies year-over-year growth of 19%-23%, driven by strong sales in April, a lower comparison in June 2018 due to a long holiday weekend and the World Cup, and more resources from the strong first quarter to reinvest in the second quarter.

We think our assumption of operating margins increasing in the long term remains valid, as we expect increase economies of scale in the direct sales business, mix shift toward the higher-margin general merchandise segment, increase in higher-margin customized electronics and home appliance products, and improving utilization of the third-party logistics business. Management guided that JD Retail’s online operating structure has a 5-percentage-point lower expense ratio than the top five offline retailers. Although heavier investment during promotional seasons can put pressure on margins in the second and fourth quarters, we think that on a full-year basis, margins will continue to increase.

In the first quarter of 2019, revenue grew 21% year over year, at the high end of guidance of 18%-22% and the same as our full-year growth forecast. Direct sales were up 19% compared with the same quarter last year; marketplace and advertising revenue grew 27%. JD reported the growth of the logistics and other services segment for the first time, which was 91% year over year. Gross margin in the first quarter was 15.0%, 90 basis points higher than the same period last year, led by a 0.6-percentage-point gross margin increase at JD Retail (previously JD Mall) mainly driven by economies of scale from the first-party business, higher mix from the higher-margin advertising revenue, and better pricing and utilization at the JD Logistics third-party business. The initial discounted period at JD Logistics gradually phased out in the second half of 2018. Non-GAAP operating margin was 1.6%, an increase from 0.8% in the same quarter last year, driven by the 60-basis-point JD Mall non-GAAP operating margin increase and improved unit economics at the JD Logistics business.

Reported operating cash flow was CNY 3.3 billion compared with a loss of CNY 3.8 billion in the same quarter last year. Excluding the disposal of logistics facilities and real estate properties, free cash flow would be negative CNY 1.2 billion on our estimate, compared with CNY 8.8 billion in the same period last year. We expect to see lower capital expenditure in 2019 versus 2018, which included investment in servers and equipment and a nonrecurring capital expenditure related to the headquarters. Management targets a decline in capital expenditure this year, and we currently expect an 8% decline in capital expenditure in 2019, translating to a capital expenditure/sales ratio of 3.5%. We assume that this ratio will be flat at 3.3% in the rest of the years.

JD renewed its strategic partnership agreement with Tencent until May 2022 for a payment of over $800 million spread across three years. JD will issue Class A ordinary shares to Tencent for a consideration of over $250 million. JD will continue to have access points on Weixin and will cooperate in terms of membership with Tencent Video and Tencent Music. The Series A financing for JD Health, the largest online retail pharmacy in China with an online healthcare services platform, values the business with a postfunding valuation of approximately $7 billion.