JD.com's (JD -1.85%) third-quarter earnings announcement surprised investors. The Chinese e-commerce company generated revenue of $12.6 billion, a 39% year-over-year increase that narrowly beat analyst expectations. However, shares initially gained as the company defied Wall Street by posting an unexpected quarterly profit of $147 million in net income from continuing operations.
This continues a great year for the company. As of this writing, shares are up over 50% year to date. However, as long-term investors, we're less worried about the next quarter and more concerned with the next five years and beyond. When viewed from that perspective, JD.com has both company-specific and macro-level drivers that point to decades of growth.
Logistical advantage is key
JD.com's true competitive advantage over retail competition is its logistical network. The company has spent tremendous sums on distribution and fulfillment centers to improve its last-mile reach, compared to most retailers that continue to rely heavily on third-party providers. Unlike the United States, where package delivery is efficient, many third-parties in China are still developing their delivery routes, and reliable service is not guaranteed.
In April, the company launched JD Logistics to help other businesses improve their supply chains, a testament to the company's strength in this area. In the third quarter conference call, founder and CEO Richard Liu spoke to these advantages:
So we have two key competitive advantages: First is our supply chain resources, because many of the suppliers to the convenience stores are already our biggest partners such as P&G. So we will help these brand partners to penetrate and reach those convenience stores as part of their channel expansion. Yes, the second advantage is our logistics network. By the end of this year, we are already covering 100% of the provinces and counties, and we can also serve even the rural areas.
That edge should continue to pay literal dividends for its retailing business. In China, the top 20 retailers only have 12% market share versus 45% for the United States. JD.com should be able to steal market share in the years ahead by offering better service and delivering products faster than its peers. The company understands this and is committed to building out its delivery network as a competitive advantage. According to Liu, "Our logistics systems can be unmanned and 100% automated in five to eight years."
China is not a winner-take-all market
It's important investors understand that expectations for JD.com are high. Although the company only turned a small profit this quarter, it's valued at nearly $60 billion. Much of its valuation is predicated on strong growth in the years ahead. Some investors are fearful of competition from Alibaba, a company many refer to as the "Amazon of China". However, in addition to the logistical advantage noted above, JD.com also controls its own inventory whereas Alibaba acts as a facilitator between buyers and sellers. Controlling inventory is an important advantage in a country where counterfeit goods are rampant.
However, it's a folly to think of the battle between JD.com and Alibaba as a winner-take-all battle. Long-term demographics support success for both companies. Currently, internet penetration in China is only 14%, but it has rapidly increased from just 6.2% in 2012. Expect this number to continue to climb, bringing millions of new consumers with it. A recent report from the Brookings Institute expects middle-class consumption to grow from $4.2 trillion in China in 2015 to $14.3 trillion in 2030. The combination of a growing base of online consumers and increased disposable income are major demographic tailwinds for companies across the Chinese e-commerce market.
Partnering with the king of retail
Last year, JD.com was able to form a strategic partnership with Wal-Mart. The latter not only took a 5% stake in the company, but it also agreed to combine their supply chains. As a result, Chinese consumers get access to new, imported products, and both companies can leverage JD.com's logistical network, serving some 600 million consumers.
This investment from the world's largest retailer served as a huge vote of confidence in the Chinese retailer, and as its tailwinds grow, makes JD.com worth a closer look from investors.