JD.com: 'One-Trick Pony' Gains a Set of Tricks – Initiate with Hold [2/2]

This article is part II of our analysis on Meicai – check out part I before you read. 

► JD.com's expanded category mix change effectively makes up for the weakness of the home appliance sector – as Suning catches up. Superior advantages in 3C make JD an unwelcoming 'one-trick pony' on capital markets, but the company's category mix change alleviates the concerns. Low marketing spending and increase of order value of categories like FMCG, clothes and underwear and beauty, some with low margins, can turn the new categories profitable. A more balanced category strategy is highly aligned with JD's reform to put user experience as the top priority.
► Similar to Amazon, membership services may become the next profit engine, as the two companies are enjoying benefits in terms of sales and users' numbers.

JD started with the home appliance business, so its online share has always been the first, accounting for 37.3% in 2019. From the perspective of omnichannel in 2019, Suning ranked first with a market share of 22.8% as the company previously focused on the offline market, and its offline market share reached 18% in 2019. However, JD.com acquired Five Star Electric in August 2020 with a wholly-owned subsidiary and implemented an omnichannel layout, which has impacted Suning's offline dominance.

Though the home appliance market as a whole is shrinking, JD.com's multi-category mix strategy can effectively make up for the weakness of the home appliance sector.

Member services may become the next growth engine

According to QuestMobile, China's mobile Internet monthly active users fell from 1.138 billion to 1.136 billion in the second quarter of 2019, a decrease of 2 million. This shows that the dividends of natural traffic growth are gone, and the next step is to grab the 'cake' from each other. In addition to social e-commerce, content e-commerce and new retail, a paid membership is one of the few relatively mature practices.

Amazon launched its membership service in 2005. At present, the total number of Prime members exceeds 100 million, and the per capita spending exceeds USD 1,200, which is twice that of ordinary members. But this method is currently challenging to implement in China. Amazon Prime members enjoy free home delivery within two days across the country, while regular users have a free shipping threshold, and the delivery time is 5-6 days. The advantages of paying members are apparent. However, in the Chinese market, free shipping and two-day delivery are the industry averages. The cost-effectiveness of continuous improvement is not high, so paying members cannot enjoy a differentiated experience.

The innovation of JD PLUS is the launch of 'JD+iQIYI' joint membership. Five months later, the number of PLUS members reached 10 million. The main reason is that entertainment has a paid tradition, while e-commerce does not. Besides, Amazon Prime can only maintain its rapid growth momentum after it covers entertainment content such as videos, music, and e-books.

On the other hand, JD.com launched a strategy of 'Member Day + Price Promotion + Member Price.' The advantage of promotional activities is that the cost of promotional activities has been included in the cost calculation of pricing, and in most cases, can be shared with the supplier. Therefore, the platform input cost is entirely controllable.

JD's big data shows that PLUS members have contributed more than 60% of sales to maternal and child brands. This model, which is still young in China, is likely to bring the same benefits to JD.com as Prime brings to Amazon.

Valuation

We drive a Dec-20 price target of USD 84 from a DCF methodology, assuming a WACC of 9.8%. We apply a 2% perpetual growth rate. Our price target implies a 9% upside – therefore, Initiate with a Hold rating. The revenue growth forecasts for 2020/21/2022 are 20%/20%/18% driven by 1. Unique consumer experience leveraging the logistic network, 2. The membership system expects to retain customers and improve mindshare gain, 3. higher monetization rate of the 3P business. We expect short-term gross profit margin will improve slightly due to the decrease in fulfillment expense rate and increased monetization rate. Still, the company's rapid user growth in the sinking market can inhibit the rise of Pinduoduo. At the same time, JD Logistics has opened up third-party logistics services to drive the rapid growth of innovative businesses; JD Health, as the third unicorn incubated by the company, performed brilliantly under the epidemic, with a year-on-year growth rate exceeding 100%. Synergistic efforts in innovative businesses create a second growth curve for the company.