Pointless Spending Is at the Root of the JD Stock Growth Problem

Spending was up, but it didn't help JD stock

Why JD Stock Has the Potential to Trade Above $30

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JD.Com (NASDAQ:JD) doesn’t have a revenue growth problem. Last quarter’s top line of $18.5 billion not only topped expectations of $17.84 billion. JD stock isn’t following that trend, though.

Where China’s (distant) second-biggest ecommerce player is beginning to struggle in a big way, however, is with its bottom line. For its second quarter of the year, the company booked a loss of five cents per share versus analyst expectations for a profit of ten cents per share of JD stock. JD reported a profit of ten cents per share in the comparable quarter of 2017.

What happened? The obvious answer is, the organization spent more. The more meaningful answer is, JD.Com is being forced to spend more in order to remain competitive with its much bigger rival Alibaba Group Holding (NYSE:BABA).

If major expenditures are the company’s go-to weapon in that war though, it’s not clear when or even if JD stockholders will ever see expense growth bridled again.

Where’s the Money Going?

JD didn’t even bother trying to disguise why expenses soared like they did. Indeed, CFO Sidney Huang said 2018 would be, “an investment year” for the organization’s logistics arm; it’s buying warehouses and new technologies that beef up its position as a provider of services to other retailers.

JD’s CEO Richard Liu’s commented: “We will continue to prioritize technology innovation to empower our partners with enhanced capabilities and improved efficiency, helping us to realize our ‘Retail as a Service‘ strategy, and driving our next phase of growth,” was no less cryptic.

That prioritization and investment, by the way, translated into roughly $400 million worth of research and development outlays, up a stunning 80% from year-ago levels.

That line on the income statement may have seen the biggest jump from Q2-2017’s totals, though little forward progress was made with other categories of spending.

The company’s total cost of revenues grew 31%, in line with sales growth, as JD.Com was forced to make price cuts.

Kim Eng Securities analyst Mitchell Kim explained: “June was a heavy spending quarter and it’s obvious they had to respond to promotions that just about everybody is doing… these promotions eat away on gross margins.”

Even beyond that though, fulfillment costs were up 28% for the quarter in question. Marketing spending was up 29% year-over-year. Administrative costs grew 23%, and stock-based compensation was up 29%, from $110 million to $142 million.

Broadly speaking, the bigger a for-profit corporation gets, the more profitable it becomes, and the wider profit margins it boasts. Investors are not yet seeing this consistently happen for JD.Com. Its Q2 numbers served as a reminder of this reality.

No End in Sight

One quarter does not make a trend, to be fair, and last quarter’s enormous swell in R&D was likely something of an outlier. It’s also unlikely the need to spend heavily on tech and capacity can be fully condensed into one quarter though. In fact, Huang said the company will “maintain a balanced, long-term approach to investing in the technologies that will define the future of retail.”

That’s CFO-speak for “look for more of the same kind of spending going forward.”

Given the spending habits and deep pocketsof the companies it competes with, like Alibaba, Amazon.com (NASDAQ:AMZN) and the aforementioned Vipshop (NYSE:VIPS), it’s not clear JD stock owners will ever see a time the company will be allowed to put on the spending brakes.

Alibaba has good reason to keep JD.Com in its distant-second positions, and can and will outspend its smaller rival to maintain its relative market share.

JD did subsequently announce that it was looking to offload the management of its warehouses to a separate business unit as a means of restoring some of the profits lost when it took on the growth initiative.

That may only be a bookkeeping-based restoration of JD’s respectable bottom line growth though. The maneuver wouldn’t actually make the warehouses less expensive to manage or more fruitful to operate. The fiscal results those facilities drive would simply be moved under another umbrella, but still ultimately accounted for somewhere on the company’s books.

In the meantime, there’s no reasonable assurance JD won’t be forced to continue discounting and spending more and more an marketing to keep up with rivals.

Bottom Line for JD Stock

When JD.Com was in high-growth mode, profits weren’t a priority. China’s ecommerce market was maturing, as was JD itself, profitability would come later.

Both are much more mature now, however, and the rising tide isn’t lifting all boats equally. Alibaba is able to leverage its size and spending power to keep outfits like JD.Com and Vipshop on the defensive rather than letting them play offense.

It’s akin to the way Amazon has remained the dominant player of North America’s e-commerce scene. It was willing and able to outspend most other would-be players.

That doesn’t mean JD is a lost cause or that JD stock is worthless. It does mean, however, that JD stockholders may want to think about resetting their expectations. Last quarter’s spending was likely a glimpse of the new norm now that China’s ecommerce market is all grown up. JD stock has to start bearing more fruit with its investments if it can.

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.


Article printed from InvestorPlace Media, https://investorplace.com/2018/08/jd-stock-growth-problem/.

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