Is Vipshop Still an Undervalued Underdog in China's E-Commerce Market?

Vipshop's (VIPS -0.26%) stock recently dipped after the Chinese e-commerce company followed up a solid third-quarter earnings report with soft guidance for the fourth quarter.

Its revenue rose 10% annually to 19.6 billion yuan ($2.7 billion), beating estimates by $90 million and marking a slight acceleration from its growth in the second quarter. Its net income surged 283% to 875.5 million yuan ($122.5 million).

On a non-GAAP basis -- which excludes stock-based compensation, gains and losses from investments, and other one-time adjustments -- Vipshop's net income rose 140% to 1.2 billion yuan ($168.3 million), or $0.25 per share, and beat expectations by nine cents.

Image source: Getty Images.

However, Vipshop expects its revenue to rise just 0%-5% annually in the fourth quarter, compared to expectations for 6% growth. That downbeat guidance stunned investors, because Vipshop's fourth quarter includes both Singles Day (Nov. 11), China's equivalent of Black Friday, and its own Anniversary Sale on Dec. 8.

Vipshop's slowdown is disappointing, but the stock still looks cheap at less than 12 times forward earnings. Should investors still consider Vipshop to be an undervalued underdog in this crowded market?

A resilient underdog

Vipshop was one of the first flash sale marketplaces in China. That first mover's advantage allowed Vipshop to defend its niche as bigger rivals like Alibaba (BABA 0.30%) launched their own flash sale sites.

Vipshop controls just 1.2% of China's e-commerce market, according to eMarketer, which puts it in sixth place behind Alibaba, JD.com (JD -0.26%), Pinduoduo (PDD -0.69%), Suning, and Gome, in that order.

But in late 2017, JD and its top stakeholder Tencent (TCEHY) co-invested $863 million in Vipshop to widen their moats against Alibaba. Both companies tethered Vipshop's marketplace to their own ecosystems.

JD integrated Vipshop's flash sale marketplace into its own, and Vipshop launched e-commerce "mini programs" for Tencent's WeChat, the top messaging platform in China. Tencent also bundled Vipshop's Prime-like "Super VIP" membership plans with new Tencent Video subscriptions. Nearly a quarter of Vipshop's new customers now originate from JD and Tencent's platforms.

Image source: Getty Images.

Is the "Tencent and JD" effect wearing off?

The bulls believe that Tencent and JD's support will help Vipshop grow over the long term. The bears believe that boost could be short-lived, and that it could gradually lose ground to other discount rivals like Pinduoduo (PDD -0.69%).

However, Vipshop's core growth metrics still look resilient. Its active customers grew 21% annually to 32 million (including 2.5 million Super VIP members) in the third quarter as its total orders surged 33% to 127.6 million. Both metrics continuously grew by the double digits over the past year:

YOY = Year-over-year. Source: Vipshop quarterly earnings.

This indicates that the "Tencent and JD" effect remains a long-term tailwind. Furthermore, Vipshop's gross and operating margins both expanded year-over-year, even as it operated about 300 experimental brick-and-mortar stores.

Source: Vipshop quarterly earnings. *Non-GAAP.

Its gross margin dipped sequentially, but the decline was expected due to lower sales of higher-margin apparel during the hotter summer months.

However, Vipshop's ARPU (average revenue per user) still fell annually during the third quarter as new customers spent less money than older customers. Vipshop also offered more lower-ticket promotional items to lock in shoppers. Those trends aren't healthy, but they aren't weighing down its margins too heavily yet.

But what about that guidance?

Vipshop's third-quarter growth looks decent, but its fourth-quarter guidance for 0%-5% revenue growth is still troubling.

Investors should note that Alibaba's Singles Day sales grew at its slowest pace in a decade this year, so it could be even tougher for smaller players like Vipshop to generate meaningful growth. CEO Eric Shen suggested that Vipshop's fourth-quarter guidance was "modest" during the conference call, but that comment didn't prevent the stock from tumbling after the report.

Stick with Alibaba or JD instead

Vipshop won't fade away anytime soon, but the business is too wobbly and the stock is too volatile for my tastes. It trades at a lower multiple than Alibaba or JD, but investors should stick with those two market leaders until the market gains an appetite again for second-tier Chinese e-commerce players like Vipshop.