2018 has been a year to forget for JD.com (NASDAQ:JD). Shares of the Chinese e-commerce specialist have fallen 44% -- the company has consistently missed earnings due to increased investments in its delivery network, and a scandal surrounding the arrest of CEO Richard Liu made the stock sink further in September.
However, there seems to be some good news on the horizon for the beaten-down stock. JD is beginning to unlock the value of its delivery infrastructure by opening its delivery network to packages shipped by businesses and consumers. The service will begin in Beijing, Shanghai, and Guangzhou, and will eventually cover all of mainland China. JD's delivery network, which had 521 warehouses as of June 30, already reaches 99% of the population and can deliver more than 90% of orders in one day or less.
The move will make it a direct competitor to ZTO Express (NYSE:ZTO) and SF Express, the equivalent of FedEx (NYSE:FDX) and UPS (NYSE:UPS) in China, as JD company prepares to leverage its sizable infrastructure. Showing that the company sees this as a competitive strength and an advantage, a JD spokeswoman told the Wall Street Journal, "In China, there are very few nationwide logistics providers and none with our reach, speed and integrated supply chain capabilities. We think that, by opening up our technology and infrastructure to more shippers, we can put all logistics assets to better use."
A power play
JD has been growing its delivery network aggressively, opening a new warehouse about once every two days over the last year. The company now has 15 logistics parks, 7,000 delivery and pickup stations, and 250,000 transportation vehicles, and that network handles 95% of JD's own deliveries.
JD's shares have taken a hit while it's made these investments, but that expansion now appears to be paying off as the company opens up the network. As I've argued before, JD's aggressive expansion and slim profits resemble Amazon (NASDAQ:AMZN) in 2014, when the e-commerce giant was heavily investing in its own infrastructure, operating at breakeven until its stock exploded alongside fast-growing profits.
Amazon has long wanted to realize a similar capability to JD's logistics network, but the company is still largely dependent on third-party shipping companies like FedEx, UPS, and the Postal Service. It now has a fleet of branded trailers and planes, and has experimented with "Flex" drivers, contractors who deliver Amazon packages using their own vehicles; but the extent of JD's network makes it seem more advanced than Amazon in some ways. According to JD, the company "is the only large-scale e-commerce company in the world to operate a nationwide in-house logistics network, down to the last mile."
Profits on the way
E-commerce direct selling is a notoriously low-margin business. JD Mall, the company's core direct sales, had an operating margin of just 1.1% in its most recent quarter, and Amazon's e-commerce business has always generated slim profit margins, if any. However, JD's supplemental businesses, like "logistics and other services", are growing fast: Sales in that segment jumped 151% in the first half of the year to $772 million, and the recent move to open up the logistics network should drive further growth.
That's good news for investors, because shipping companies are significantly more profitable than e-commerce direct sellers. UPS had an operating margin of 9.8% in its most recent quarter, while FedEx's was 7.7%. The industry has high barriers to entry, meaning there are few other providers outside those two and the Postal Service, protecting those margins. In China, ZTO posted a whopping operating margin of 27.2% in its most recent quarter, and the company has delivered operating margins of 25% or better since 2015.
Since JD is already operating its delivery network for its own use, the additional parcels shipped almost function as incremental sales, using the same warehouses and freight that it's already built and already owns. That means that the third-party logistics business should be significantly more profitable than its core e-commerce business.
Much like Amazon has, JD is unlocking the power of its e-commerce ecosystem to build more profitable third-party businesses. With the stock near all-time lows, that should reassure investors at a time when they could use some good news.
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Jeremy Bowman owns shares of JD.com. The Motley Fool owns shares of and recommends Amazon and JD.com. The Motley Fool recommends FedEx. The Motley Fool has a disclosure policy.