Shares of JD.com (NASDAQ:JD) fell 5% on May 9 after the Chinese e-commerce company reported a mixed first quarter. Its revenue rose 33% annually to 100.1 billion RMB ($16 billion), beating estimates by 1.2 billion RMB. However, its non-GAAP net earnings fell 23% to 0.71 RMB ($0.11) per ADS, missing expectations by 0.11 RMB.
That earnings miss was attributed to its cost of revenues jumping 33.5% annually and outpacing its revenue growth. Its fulfillment expenses climbed 39.3%, marketing expenses rose 24.7%, and technology/content expenses jumped 87.2% due to heavy investments.
As a result, JD reported a negative free cash flow of negative 8.8 billion RMB ($1.6 billion), and its adjusted EBITDA slid 16% to 1.9 billion RMB ($298 million). Those numbers likely drew some bears to the stock, which has fallen more than 10% this year.
The bears often claim that JD, the second largest e-commerce player in China, remains at a disadvantage against market leader Alibaba (NYSE:BABA). They also warn that JD will struggle to match Alibaba's sales growth, and that its margins will contract as it tries to compete.
However, that argument overlooks key facts about JD's growth potential. I personally think that the bears are wrong about JD's future, for four simple reasons.
1. JD.com and Alibaba aren't comparable
JD's business isn't directly comparable to Alibaba's. JD's core business is a B2C (business-to-consumer) marketplace, in which JD handles most of the fulfillment and logistics via its own warehouses and couriers. A smaller part of its marketplace lets vendors fulfill orders by themselves. This business model is similar to Amazon's (NASDAQ:AMZN) marketplace.
Alibaba has two main marketplaces: Taobao and Tmall. Taobao is a C2C (consumer-to-consumer) marketplace like eBay, which isn't comparable to JD. Tmall is a B2C marketplace, but it mainly relies on third-party fulfillment and logistics services.
JD takes ownership of most of the products it sells, while Alibaba doesn't. That's why JD generates higher revenues than Alibaba, but posts lower margins. However, JD's biggest advantage against Tmall is that it can more closely monitor the quality of its products and fulfillment services.
2. Alibaba's Tmall isn't killing JD.com
Last year, Analysys International Enfodesk reported that between 2014 and mid-2017, JD's share of China's B2C market surged from 17.7% to 32.9%. During the same period, Tmall's share dropped from 54.6% to 51.3%.
JD's growth was fueled by three things: its partnership with Tencent (NASDAQOTH:TCEHY), which integrated JD's marketplace into WeChat, the top messaging app in China; a growing list of retail partners, which view JD as an anti-Alibaba play; and the collapse of smaller B2C marketplaces.
JD is still growing rapidly. Its annual active customer accounts rose 28% annually to 301.8 million last quarter, compared to its 29% growth in the fourth quarter of 2017. Its gross merchandise volume also climbed 30% to 330.2 billion RMB ($52 billion).
For the current quarter, JD anticipates 29%-33% annual sales growth after excluding the impact of its spin-off of JD Finance last year.
3. It takes money to make money
JD is often called the "Amazon of China". Investors should recall that in the past Amazon often posted strong revenue growth with simultaneous big earnings declines due to its investments in the expansion of its online marketplace, ecosystem, and fulfillment services. That's precisely what JD is doing right now.
During the quarter, JD opened 29 new warehouses, bringing its nationwide total to 515. As for R&D spending, JD is investing in better AI-driven ads and analytics for its marketplace. It also recently introduced WeChat Store Mini, a turnkey solution that lets businesses quickly open a WeChat store for the app's 989 million monthly active users.
JD wouldn't be aggressively expanding if its business were shrinking, so these investments will weigh down its margins for the foreseeable future -- but its margins will eventually expand as it reaps the returns.
4. The stock is still reasonably valued
Analysts expect JD's revenue to rise 30% this year, but the stock trades at just 1.4 times this year's sales. Alibaba, by comparison, trades at 13 times this year's sales. JD's forward P/E of 51 is higher than Alibaba's multiple of 38, but it's a reasonable ratio if JD's spending leads to stronger earnings growth over the next few years.
JD isn't an ideal investment for queasy investors with a short investment horizon. However, it could still be a great long-term play, since JD is still setting up the pieces to live up to its nickname as the "Amazon of China".