Alibaba (BABA 3.43%) and JD.com (JD 1.92%), the two largest e-commerce players in China, mainly operate with different business models.
Alibaba's online marketplaces charge listing fees and commissions for third-party sellers, use third-party logistics services to fulfill orders, and don't take on any inventories. JD is a direct retailer that takes on inventories and fulfills orders with its own logistics network.
JD generates higher revenue than Alibaba but operates at much lower margins. Alibaba founder Jack Ma once claimed that JD's low-margin approach would "end in tragedy," while JD founder Richard Liu declared that Alibaba's dependence on third-party sellers exposed its shoppers to counterfeit goods.
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But over the past few years, Alibaba quietly expanded into the direct retail market via its direct import services and Freshippo, Tmall Supermarket, and Intime brick-and-mortar stores. Let's dig deeper into these businesses, and see why they indicate that Alibaba is quietly becoming more like JD.
Examining Alibaba's New Retail business
Alibaba refers to its brick-and-mortar stores as its "new retail" business. It lumps those stores together with its direct sales business in the "others" segment of its core commerce revenue.
Alibaba's core commerce revenue grew 40% annually to 101.2 billion yuan ($14.2 billion) last quarter and accounted for 85% of its top line. Within that total, its "other" revenue surged 125% to 18.2 billion yuan ($2.5 billion), partly due to its acquisition of NetEase's (NTES 2.76%) Kaola cross-border e-commerce marketplace.
Excluding its "other" revenue from both quarters, Alibaba's core commerce revenue only grew 29% annually, which merely matches JD's growth last quarter. This indicates that it's increasingly dependent on the growth of its brick-and-mortar stores, as well as new marketplaces like Tmall International and Kaola, which fulfills cross-border orders with its own warehouses and logistics network.
All these businesses operate at lower margins than its core online marketplaces. Furthermore, Alibaba recently boosted its stake in the logistics platform Cainiao from 51% to 63%, which moves it one step closer to becoming a first-party logistics player like JD.
Alibaba's revenue from Cainiao rose 48% annually to 4.8 billion yuan ($666 million) last quarter and accounted for 4% of its top line -- but that's also low-margin revenue. If we exclude Cainiao, the new retail, and the direct import businesses, Alibaba's core commerce revenue would have only risen 28% last quarter.
A growing dependence on lower-margin revenue
In short, Alibaba's core commerce business is relying more on low-margin businesses to boost its top-line growth. That's why the unit's operating margin fell 180 basis points annually to 31.7% last quarter, as its adjusted EBITDA margin also declined from 41.1% to 38.1%.
That trend is troubling because Alibaba's core commerce unit is its only profitable business, and those profits subsidize the growth of its unprofitable cloud, digital media, and innovation initiatives businesses.
Meanwhile, JD's operating margins have expanded in recent quarters as the evolution of its logistics service into a third-party service for other companies bolstered its margins. As a result, JD's operating margins have improved over the past five years, as Alibaba's declined:
BABA Operating Margin (TTM) data by YCharts
It's all about expanding its moat
Alibaba realizes that its investments in brick-and-mortar stores, cross-border e-commerce marketplaces, and logistics platforms will throttle its earnings growth. But these moves also widen its competitive moat.
Its expansion into brick-and-mortar stores counters JD's Dada-JD Daojia joint venture with Walmart (WMT 0.71%), which provides deliveries from a network of about 20,000 offline stores across 54 cities. It also counters Tencent's (TCEHY 2.52%) WeChat Pay, the digital payments platform that competes against Alibaba-backed AliPay. Tencent and Alibaba are both aggressively tethering brick-and-mortar retailers to those payment services.
Alibaba's takeover of Kaola makes it the top cross-border e-commerce player in China, which gives it an edge against JD in the direct import of overseas products. Its growing interest in Cainiao helps it match JD's efficiency in deliveries.
During last quarter's conference call with analysts, Alibaba CEO Daniel Zhang claimed that the company's new retail strategy would "further enlarge" its addressable market by tethering brands to its e-commerce ecosystem and "empowering" retailers with new technologies. CFO Maggie Wu also stated that Alibaba would "continue to invest" in Cainiao's logistics platform.
The key takeaways
Despite these challenges, Alibaba remains a solid growth stock. Analysts expect its revenue and earnings to rise 29% and 23%, respectively, next year -- which are impressive growth rates for a stock that trades at 24 times forward earnings.
However, investors should be aware that the core commerce business is depending more heavily on lower-margin businesses to drive its top-line growth. These moves strengthen its ecosystem, but they also mirror JD's moves -- which suggests that its rival's moves weren't so "tragic" after all.
