There’s an old adage — in the long run, every market becomes a two-horse race. It’s not universally true, but the point is well taken. One company becomes the dominant player in an industry, and every other company in the same business teams up to topple the leader.
Still, even with lots of help and plenty of motivation, fighting a bigger and better-funded rival is neither easy nor cheap. Just ask owners of China’s e-commerce outfit JD.Com Inc(ADR) (NASDAQ:JD), who’ve watched JD stock lose 12% its value since late February.
Most of that setback was in response to amazing revenue growth coupled with shrinking profits. Its ongoing rivalry with behemoth Alibaba Group Holding Ltd (NYSE:BABA) is taking a toll on the bottom line, and investors aren’t sure when — or even if — that headwind will stop blowing.
Bills, Bills and More Bills
Last quarter, JD.com beefed up its top line to the tune of 34% year-over-year, reporting revenue of $16.9 million. That’s the good news, made even better in light of the fact that analysts were only expecting sales of $16.6 million.
The bad news: Earnings of 5-cents-per-share of JD stock fell short of the 9-cents-per-share analysts had modeled, and overall net income was down nearly 17% from the comparable quarter a year earlier. The 35% increase in marketing costs like traffic acquisition costs, online marketing and logistics expenses were the crux of spending headaches for the quarter in question.
CFO Sidney Huang mostly dismissed the big increase in expenses, saying “In the short term we’ll be loss-making but we see huge potential in the technology.” The action from JD stock says the market isn’t exactly buying into the idea.
Neither are some analysts. Morningstar Equity Research analyst Chelsea Tam commented, “Although we believe JD.com will survive in the severe competition of the e-commerce space in China, backed by its alliance with Tencent, we think it will be difficult for the firm to pass market leader Alibaba.”
And, those doubts are understandable. JD’s selling and marketing expenses as a percentage of revenue have quietly been growing for a while. The ever-increasing costs only reached head-turning levels last quarter.
This isn’t the first time we’ve seen a less potent online player struggle to keep up with a bigger e-commerce rival. Indeed, the ongoing fight between e-commerce giant Amazon.com, Inc. (NASDAQ:AMZN) and brick-and-mortar retailer Walmart Inc (NYSE:WMT) is an amazingly similar story, verified again just last quarter. That’s when Walmart did quite well in terms of the top line, but fell short of profit estimates thanks to more spending and price breaks.
Kudos to Walmart for piecing together a turnaround in a tough environment. Although the pace of online sales growth fell to a pace of 23% on a year-over-year basis, 23% growth is still plenty respectable.
Nevertheless, the battle scars are becoming more evident. Its cost of sales last quarter were up 5% versus only a 4.2% increase in total revenue, as the retailer was forced to sell merchandise at more competitive prices, and forced to offer greater incentives like free shipping on many online orders.
Thing is, it’s a spending battle Walmart started to fight a year ago. If there was an end in sight, we would have spotted it by now.
Morgan Stanley analyst Brian Nowak noted of the company’s e-commerce business last quarter “WMT’s execution issue suggests 1) its infrastructure is inadequate or 2) it has yet to harmonize its omni-channel assets (3,600 Supercenters, 22 e-commerce dedicated FCs), particularly during peak demand season.” But, he went on — and this is the part that should nag at current and would-be owners of JD stock — to say that “Ultimately, we think any solution will result in increased spending, either through software, logistics or new fulfillment centers.”
Considering that, like Walmart, JD.com is the retailer whereas, like Amazon, Alibaba is largely a commission-based middleman, JD will also have to beef up everything it’s doing if it’s to have a shot at keeping up with Alibaba. That’s the upside of not actually owning all of your retail goods … incredible financial flexibility.
And anybody who’s ever had to compete head-to-head with Amazon knows it’s a company that never lets up or backs down.
Bottom Line for JD Stock
None of this is to suggest that JD.com can’t survive, or even thrive, in a world with Alibaba in it. Every company has some sort of edge it can leverage against competitors.
It is to say, however, any fan and follower of JD stock that thinks the company will ever be able to back off on its big-time spending may not want to hold their breath. At best, it’s a question of how well that ongoing spending increase pays off, near-term and long-term. It’s just the nature of the e-commerce game, where the size of the web one weaves is more important than the profits that web actually creates.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities. You can follow him on Twitter, at @jbrumley.
