Introducing: Stefanie Kammerman, Legendary Dark Pool Trader

For the 1st time ever, a former financial insider is stepping forward to show you how to spot Wall Street’s “hidden” trades before they move the market.

Wed, July 15 at 7:00PM ET

As China’s Market Cools, Patience Is the Key with JD Stock

JD stock is a classic scenario of near term pain, long term gain

JD stock - As China’s Market Cools, Patience Is the Key with JD Stock

Source: Daniel Cukier via Flickr

China e-retail giant JD (NASDAQ:JD) was once a $50 stock. Today, JD stock sits at $20 and change.

What happened? A lot of things, and none of them were good for JD. China’s economy started to cool after multiple years of red hot growth, as the urbanization tailwind started to lose some steam and rising trade tensions started to weigh on consumer sentiment.

Concurrent to this slowdown, JD’s growth rates started dropping quickly, and the company is now growing revenues at a multi-year low pace. Also, JD decided that this would be a good year to invest big into JD Logistics, so operating margins are now dropping at the same time that revenue growth is falling. Net result? Profits look exceptionally weak.

There have also been some headline risks. Notably, JD’s CEO is caught in the middle of a rape allegation, and investors are thinking that this bad publicity may be contributing to the company’s slowdown.

All together, JD stock has fallen from $50 to $20 in about ten months.

At current levels, long term upside in JD stock is compelling. You have a 20%-plus growth company that is expected to more than double earnings next year, and almost double them again the year after that. Yet, the stock trades at just 35X next year’s earnings, which is a very reasonable multiple for this type of explosive growth.

But, that doesn’t mean JD stock will bounce back any time soon. Indeed, things may get worse before they get better. Trade tensions are only heating up, and recent economic data out of China isn’t all that bullish. As such, buying the dip here looks compelling, but investors should understand that dip buying here will require caution and patience.

Why Stock Dropped

For all intents and purposes, JD is the Amazon (NASDAQ:AMZN) of China with a logistics arm. As the Amazon of China, JD has been a big growth company with improving margins for the past several years.

In 2015, JD grew revenues by nearly 60% and the core JD Mall business was barely profitable (0.3% operating margins). In 2016, revenues grew by nearly 45%, and JD Mall margins expanded healthily to 0.9%.

Same thing happened in 2017. You had big revenue growth (40%) and big margin expansion (operating margins jumped to 1.4%).

But, this big growth, big margin expansion narrative hit a road-bump in 2018. Namely, the red hot Chinese economy cooled, and JD’s growth rates fell.

Throughout the year, quarterly year-over-year revenue growth rates have dropped from 33% to 31% to 25%. In Q4, they are expected to drop further to 20%. Thus, 2018 projects to be a mid-20% growth year, versus 40%-plus growth in each of the past three years.

Concurrent to this, JD management decided at the beginning of the year that this would be a good year to invest big into JD Logistics to improve operational efficiency. That means JD Logistics margins have been killed year-to-date.

Meanwhile, JD Mall margins, after multiple years of growth, are starting to flatten out. Thus, the overall margin profile has deteriorated meaningfully this year, and profits look exceptionally weak. Weak profits usually equal weak stock, and that is exactly what you have with JD.

Long Term Upside Is Compelling

In the big picture, these headwinds are temporary. The China economy is cooling because of trade tensions, and trade tensions won’t last forever. Moreover, the ecommerce growth narrative in China remains robust and this projects to be a big-time growth industry for a lot longer.

Plus, JD Logistics margins won’t be weak forever. As investments into the Logistics business phase out, those margins will push higher, and that will bring the overall margin profile significantly higher.

Overall, this is still a 15%-plus growth company with healthy long term margin drivers. Under those assumptions, it really isn’t hard to see JD doing about $130 billion in sales in five years (15% annualized growth rate from 2018’s projected $66 billion base) with roughly 4% operating margins (consistent with where Amazon is in its domestic retail business).

Under those assumptions and assuming a 20% tax rate, $4 billion in profits by fiscal 2023 seems doable for this company.

A market-average 16 multiple on that implies a long term valuation target of $64 billion. The current market cap is about $30 billion. Thus, JD stock has doubling potential in the long run.

Near Term Weakness May Persist

Because of its tremendous long term upside potential, JD stock is a buy on this dip. But, because near term headwinds will persist, this is a dip you want to gradually buy into.

It really doesn’t look like U.S. and China trade relations are going to improve meaningfully anytime soon, as both sides are apparently playing the long game and are willing to endure near term pain.

Moreover, recent economic data out of China isn’t all that great. Overall, the operating backdrop in China will remain weaker for longer, and this dour backdrop will keep JD growth rates depressed.

Improving margins in 2019 could help sentiment. But, the big thing is slowing revenue growth. So long as growth rates continue to rapidly decelerate, the stock will remain weak.

Bottom Line on JD Stock

At current levels, long term upside in JD is compelling. But, near term headwinds remain, and those headwinds will create choppiness in JD stock for the foreseeable future. As such, while this is a dip worth buying, it is also dip that will require caution and patience.

As of this writing, Luke Lango was long JD and AMZN. 

Article printed from InvestorPlace Media,

©2020 InvestorPlace Media, LLC