Are the Bulls Right About JD.com's Upside Potential?

Check out the latest JD.com earnings call transcript.

2018 was a terrible year for JD.com (JD +0.86%), the second largest e-commerce company in China. Its stock was cut in half as its revenue growth decelerated, its profits plunged, and CEO Richard Liu was arrested on a rape allegation. Concerns about escalating trade tensions, the slowing Chinese economy, and the marketwide sell-off exacerbated the pain.

However, a few of those headwinds recently dissipated. The charges against Liu were dropped, JD restructured its businesses to prioritize the growth of JD Mall and its Services revenues, it announced a $1 billion buyback, and there were flickers of hope for a trade deal between the U.S. and China. Wall Street also refused to give up on the stock -- of the 40 analysts who cover JD, none of them have issued a "sell" rating yet; 14 of those firms still rate it a "buy."

Image source: Getty Images.

One of those firms is Goldman Sachs. Goldman analyst Ronald Keung recently reiterated his bullish stance on JD, declaring that its restructuring and an improved user experience could boost its active customers over 360 million this year -- up from 305.6 million last quarter. Keung also claims that JD experienced significant growth in monthly active users in November (during Singles Day), and that it could generate about 20% sales growth in both the fourth and first quarters -- which would roughly match analyst expectations.

Keung maintained a price target of $41 on JD -- which is significantly higher than the average price target of $28 and would mark a near-90% gain from its current price. Investors should always take analysts' ratings with a grain of salt, but are the bulls right about JD's upside potential?

Reviewing JD's biggest problems

JD's growth in gross merchandise volume (GMV), active customers, and revenue all clearly decelerated over the past year.

Data source: JD quarterly reports. Year-over-year growth. *RMB terms. 

During the third quarter, JD blamed those declines on slower sales of "large ticket" electronics and home appliances, which was partly offset by stronger demand for other general merchandise.

However, the bears will likely note that Alibaba's (BABA +1.75%) core commerce revenue rose 56% annually last quarter, compared to 61% growth in the first quarter. Alibaba also reached 601 million active buyers during the quarter -- giving it nearly double the e-commerce presence of JD.

JD's margins also contracted. Its non-GAAP gross margin fell 10 basis points annually to 15.2% as its operating margin dropped 120 basis points to 0.6%. That was caused by a 27% jump in its operating expenses -- which was led by a 96% increase in its Technology and Content costs. Those expenses are spent on improving JD's automated warehouses, its drone deliveries, logistics services, and the user experiences on its website and app.

Image source: JD.com.

Alibaba founder Jack Ma once warned that JD's capital-intensive business model would end in "tragedy," and many bears echo that sentiment. However, the bulls believe JD's investments will pay off as they streamline its business and reduce its long-term operating expenses. They'll also note that JD is now offering its logistics services to other companies -- which could generate a fresh stream of higher-margin revenue.

Are Goldman's expectations too high?

I own shares of JD, and I'm still optimistic about its growth potential, but I think Goldman Sachs' expectations for JD are too high.

For JD to hit 360 million active buyers by the end of calendar 2019, its monthly active buyers would need to grow 18% annually in the third quarter of 2018. This means JD's buyer growth must accelerate over the next three quarters -- which will be tough as the Chinese economy slows down, trade worries persist, and it continues to compete against Alibaba's Tmall.

Furthermore, Goldman's estimates for 20% sales growth in the fourth and first quarters don't indicate that JD's growth will accelerate. Keung also doesn't address the nagging concerns about its rising expenses and narrowing margins. At $41 per share, JD would trade at over 80 times earnings -- which is a lofty valuation for an e-tailer with decelerating sales growth and inconsistent profitability.

However, I believe JD's mini programs on Tencent's WeChat, the expansion of its Prime-like "JD Plus" service, the transformation of JD Logistics into a new revenue stream, and its expanding partnership with Walmart should all stabilize its growth over the long term. Investors should focus on those catalysts instead of believing rose-tinted near-term forecasts from bullish analysts.