5 Reasons JD.com Is Still an Undervalued Growth Stock

JD.com's (JD 1.23%) stock recently dipped after the Chinese e-commerce giant posted its third-quarter earnings. According to the report, its revenue rose 29% year over year to 174.2 billion yuan ($25.7 billion), beating estimates by $610 million. Its adjusted net income rose 80% to 5.6 billion yuan ($0.8 billion), or $0.50 per ADS, which topped expectations by nine cents.

Those growth rates were impressive, but some investors were likely itching to lock in profits after the stock had rallied about 150% this year. But as someone who stuck with JD over the past two years, I believe this stock remains undervalued relative to its growth, for five simple reasons.

Image source: JD.com.

1. Revenue growth is robust

JD's revenue growth in this latest quarter decelerated from its 34% growth in the second quarter, but that slowdown wasn't surprising because it held its annual 618 Grand Promotion sale in June. However, JD's revenue still accelerated from the prior-year quarter:

YOY = Year over year. RMB terms. Source: JD.com.

JD attributed that growth to robust sales of its general merchandise, led by online grocery and healthcare products, as well as consumer electronics and home appliances.

JD's services revenue surged 43% year over year and accounted for 13% of its top line, as JD Logistics served more third-party customers (which generated nearly half its revenue in September) and it sold more ads across its marketplaces.

JD didn't provide any guidance for the fourth quarter, but analysts expect its revenue to rise 36% as Singles Day in November brings in even more shoppers. JD's revenue is expected to rise by 36% for the full year.

2. JD is accelerating growth in active customers

JD's number of annual active customers rose 32% year over year to 441.6 million in the third quarter, marking its highest growth rate in three years.

YOY = Year over year. Source: JD.com.

JD typically struggles to attract new shoppers in the third quarter due to a lack of major shopping holidays, but its ongoing push into lower-tier cities -- which contributed roughly 80% of its new users during the quarter -- paid off this year.

That growth could widen JD's moat against Pinduoduo (PDD 0.24%), which targets lower-income shoppers with its discount marketplace, and Alibaba (BABA 0.09%), which is also expanding into lower-tier cities.

JD Plus, a premium subscription tier that offers discounts, free shipping coupons, and other perks from over 600 partners, also reached 20 million subscribers during the quarter. That sticky ecosystem could lock in more shoppers and support the growth of newer services like JD Health, its online pharmacy, and telehealth system, which grew significantly throughout the pandemic.

3. JD's margins are expanding

JD takes on inventories and fulfills its orders with JD Logistics. By comparison, Alibaba connects buyers to sellers, doesn't take on inventories, and fulfills orders with its Cainiao logistics service.

Image source: JD.com.

JD's business model is more capital-intensive than Alibaba's, but it enables JD to maintain tighter control of its orders and protect shoppers from counterfeit products. JD's hefty infrastructure investments throttled its earnings growth for years, but economies of scale are now finally kicking in.

In other words, JD's fulfillment network -- which includes automated warehouse robots, driverless delivery vehicles, and drones -- now operates efficiently enough to generate stable profits. It's also generating more higher-margin service revenue from third-party customers that use that massive network.

As a result, JD's adjusted operating margin expanded 80 basis points year over year to 3%, while JD Retail's adjusted operating margin (which only includes its marketplaces) rose 60 basis points to 3.9%. Its total adjusted EBITDA margin also expanded from 3.1% to 3.8%.

Based on those improving margins, analysts expect JD's adjusted earnings to rise 53% this year.

4. Surging cash flows will help future investments

JD's robust earnings growth caused its trailing 12-month free cash flow to rise 93% year over year to 30.2 billion yuan ($4.5 billion). Its cash and equivalents also surged 98% to 73.1 billion yuan ($10.8 billion), which will give it plenty of room for future investments.

5. Ridiculously cheap valuations

Generally speaking, if a company's forward P/E ratio is lower than its earnings growth, its stock is undervalued. If a company's market cap is equal to or lower than its annual revenue, it's also considered cheap.

Analysts expect JD's revenue and earnings to rise by 22% and 44%, respectively, next year. Based on those estimates, its stock trades at 41 times forward earnings and about one time next year's sales.

Those valuations -- along with JD's impressive growth in revenue, users, and margins -- all indicate it's still an undervalued growth stock. Therefore, I wouldn't be surprised if JD doubles again within one or two years.