It has been a turbulent past few years for investors in Chinese e-commerce giant JD (NASDAQ:JD), with most of that volatility in JD stock driven by fluctuations in the company’s revenue growth rates and operating margins.
Back in 2016, JD was a $20 stock. Then, from the back-half of 2016 and through to early 2018, JD’s operating margins materially improved against the backdrop of sustained big revenue growth. Profits were consequently soaring, and investors were taking an increasingly constructive outlook on JD’s long-term profit potential. In response, JD stock soared to $50 by early 2018.
But then things changed. JD’s revenue growth rates started to meaningfully slow. Operating margins started to retreat. Profit growth fell flat. Investors became increasingly pessimistic on JD’s long-term profit growth potential. JD stock dropped back to $20 levels by late 2018.
Coming into this year, things started to improve again. JD’s revenue growth rates stabilized. Margins began to creep higher. Investors got bullish again. JD stock soared to $30.
In other words, history says that as go JD’s revenue growth and margin trends, so goes JD stock.
Distracted by Trade War Noise
Recently, JD stock has taken a step back on trade war concerns. Such concerns are just noise. In the bigger picture, the fundamentals imply that JD’s revenue and margin trends will remain favorable over the next few quarters. As they do, JD stock will bounce back from this recent sell off in the near term, and surge higher in the medium term.
As such, this dip in JD stock is worth buying. Near to medium term upside looks compelling at the current moment.
Revenue Trends Remain Favorable
The first big reason to buy the dip in JD stock is because the company’s revenue trends are improving, and should be favorable for the foreseeable future.
To understand this, let’s take a step back and look at the Chinese economy as a whole. The trade war is escalating. That’s not good for China’s economy. Specifically, it weighs on China’s trade — exports and imports will both presumably take a hit for the foreseeable future. Trade is a big part of China’s economy. Thus, as trade takes a hit, so does China’s GDP. That’s why you are seeing these decade-low GDP prints out of Beijing.
But, amid all this trade noise, it’s important to separate out the consumer. The trade war isn’t all that relevant to the consumer, in either China or the U.S. Sure, it means higher prices in some places. But, only marginally higher prices. Such price hikes won’t derail either countries’ consumer economies. Instead, those consumer economies are driven by still favorable labor conditions. Indeed, as 30 year-old Shanghai clerk Roman Wu said in a recent UBS survey, “consumers like me will spend more, for as long as we keep our jobs and our income continues to rise.”
China’s Consumers Keep Spending
That’s exactly what is happening in China. China’s unemployment rate has dropped to a decade-low 3.6% in 2019, while wages have risen to a decade-high, up more than 6% year-over-year in the first half of 2019 in major Chinese cities. That’s why Chinese retail sales growth trends have improved meaningfully over the past few months after a temporary slowdown in early 2019, and why June 2019 retail sales growth was the highest its been since since March 2018. It’s also why, according to that same UBS survey, most Chinese consumers actually expected to keep spending big both now and for the foreseeable future.
In other words, China’s consumer economy remains largely isolated to the trade war, and favorable labor conditions project to keep China’s consumer economy on a healthy upward path for the foreseeable future. This will create a rising tide that will lift all boats — JD included — and which should help stabilize JD’s revenue growth rates in the ~20% range for the foreseeable future.
Margins Will Keep Powering Higher
The second big reason to buy the dip in JD stock is because the company’s margin trends have meaningfully improved over the past few quarters, and project to keep improving for the foreseeable future.
JD is a big growth company in a big growth market. As a big growth company in a big growth market, the company is investing a bunch of money back into the business to expand market share and improve long term efficiency. This includes investing in things like expanding geographic operations and optimizing warehouse logistics with robotics. Near term, these investments have a hugely negative impact on margins, because they have sizable upfront costs. Long term, these investment have a hugely positive impact on margins, since they expand scale and improve efficiency.
It increasingly appears that JD is in the phase of the investment cycle where these investments are going from having a “hugely negative impact” on margins to having a “hugely positive impact” on margins. Specifically, for most of 2018, margins were under pressure. In the last quarter of 2018, though, JD Mall reported 50 basis points of margin expansion. JD followed that up with 20 bps of expansion in the first quarter of 2019, and 60 bps of expansion in the second quarter of 2019.
That’s a favorable multi-quarter margin expansion trend. Further, management commentary on the Q2 conference call broadly implied that JD is the early innings of a realizing the long-term margin benefits of its 2017-2018 operational investments.
Net net, then, JD’s margin trends are finally starting to improve, and it appears that they will continue to improve in a big way for the foreseeable future.
Bottom Line on JD Stock
In the big picture, only two things drive JD stock: revenue growth and margins. When both are trending in the right direction, JD stock powers higher. When both are trending in the wrong direction, JD shares falls off a cliff.
For the foreseeable future, both revenue growth and margins project to trend in the right direction. Thus, for the foreseeable future, JD.com stock should remain on an uptrend, meaning that trade war related dips in the stock are nothing more than buying opportunities.
As of this writing, Luke Lango was long JD.
