The macro outlook for Chinese e-commerce giant JD.com (NASDAQ:JD) is actually quite strong. While the coronavirus outbreak has been a tragedy, especially for China, fear about the outbreak is starting to abate. That’s because realistic hopes for a cure have arisen and investors are internalizing that, thankfully, the disease’s mortality rate is quite low compared with other, recent epidemics. Meanwhile, the positive impact of the U.S.-China trade deal on China’s economy, along with stimulus measures recently introduced by Beijing and the rebounding European economy, have yet to be reflected in most Chinese stocks, including JD stock.
On the micro level, JD’s results shouldn’t be hurt too much by the coronavirus outbreak, as many people who stayed home as a result of the outbreak probably ordered more products than usual from e-commerce companies, including JD.
Moreover, the company’s strategies of targeting China’s second-tier cities (cities that are less populated than the country’s largest municipalities) and taking steps to lower its delivery costs appear to be working. Finally, its logistics unit looks poised to become very profitable.
Let’s take a closer look at each of these points.
A Cure for Coronavirus Is Likely to Be Launched Soon
Researchers in China and the U.S. have reportedly found potential cures for coronavirus.
The potential cure from American company Gilead (NASDAQ:GILD) sounds particularly promising. Preclinical tests showed that a drug the company developed as a treatment for Ebola is effective against two other viruses, Middle East Respiratory Syndrome (MERS) and Severe Acute Respiratory Syndrome (SARS).
Both MERS and SARS have similarities to the coronavirus. Moreover, the condition of an American coronavirus patient who received the drug improved meaningfully the day after it was administered. Because the safety of the drug, remdesivir, has already been tested, a Phase III trial of the treatment is already being prepared in China. I believe that if the drug is shown to be effective against the coronavirus at the outset of the trial, it will quickly be distributed to all coronavirus patients. Thus, a cure could be ready within a few weeks or sooner.
Further, I think the market is internalizing that the outbreak is largely isolated to the Chinese province of Hubei. As of Feb. 5, 414 of the 490 worldwide deaths from coronavirus had occurred in the province. The 414 total may not include people who contracted the illness in the province in Hubei and then traveled elsewhere before dying. Moreover, the overall mortality rate of the illness is much lower than other outbreaks this century.
Macroeconomic Trends Are Improving
I think that Chinese stocks, including JD stock, do not reflect the tariff reductions and increased certainty brought out by the Phase I trade deal signed between the U.S. and China. That’s because, soon after the deal was signed, the coronavirus outbreak started. The trade deal will greatly curtail or stop the outflow of manufacturers from China, while causing businesses to invest much more money in the country. Additionally, Beijing’s recent injection of $88 billion into the country’s banking system should further boost its economy.
Finally, things are looking up for the E.U., China’s largest trading partner. The euro zone’s January purchasers’ managing index came in at 51.3, a five-month high that beat the average estimate. Moreover, an index of the German services sector came in at a five-month high of 54.2, versus December’s level of 52.9.
JD’s Micro Trends Are Positive
JD’s revenue and profits are both growing rapidly. In 2017, its revenue was 362 billion yuan. Its top line jumped to 462 billion yuan in 2018 and 541 billion yuan over the 12 months that ended in September 2019. Its bottom-line gains have been even more impressive, as its operating income was 7.9 million yuan in 2017, a 1.98 billion yuan loss in 2018, and a 6.6 billion yuan gain in the 12 months that ended in September 2019. Those figures show that its strategy of concentrating on China’s second-tier cities, selling only products it has acquired, and investing heavily in logistics is working.
The company has encountered less competition in the second-tier cities, and it says that the residents of those areas actually have a meaningful amount of disposable income, even though their salaries are lower, because their housing costs are lower.
Moreover, its strategy of only selling goods it has acquired has enabled it to effectively avoid selling defective or counterfeit products, which are major problems in China. And its extensive investments in logistics has lowered its delivery costs, raising its profitability.
Finally, its heavy investments in logistics look poised to give it a new source of high profits in a year or two. That’s because its logistics have gotten so good that many other companies are paying JD to deliver products for them. 40% of the revenue its JD Logistics unit obtained in Q3 came from outside customers, and the unit’s revenue surged 62% YoY to $823 million in Q3. Its operating loss fell to 1.27 billion yuan from 1.54 billion yuan during the same period a year earlier. Given the unit’s extremely strong revenue growth and the explosive growth of e-commerce in China, I think it’s clear that the unit will be extremely profitable in a year or two.
Finally, JD has probably not been hurt too much by the cornavirus outbreak, since demand for e-commerce likely was strong as many people avoided brick-and-mortar stores. Additionally, the company’s heavy utilization of drones and robots has probably made it less susceptible to labor shortages during the outbreak than many of its competitors.
The Bottom Line on JD Stock
Macro trends appear to be favorable for JD, as China’s economy looks poised to rebound and the coronavirus looks poised to come under control. Despite the company’s strong growth and the high chances of its logistics unit becoming extremely profitable, JD’s shares are changing hands at just 29 times analysts’ average 2020 earnings-per-share estimate. Given all of these considerations, JD stock is worth buying now.
As of this writing, Larry Ramer did not hold a position in any of the aforementioned securities.
