Shares of Chinese technology stocks surged on Tuesday, Aug. 24, after a slew of positive earnings surprises from several key names, including e-commerce giant JD.com (JD +0.88%). In fact, JD's results were so good that ARK Invest CEO Cathie Wood, after selling her Chinese stocks earlier this year, bought some shares following the company's second-quarter earnings report.
Beyond the mere good results, management also offered commentary on China's regulatory campaign against big tech excesses. While new regulations may temporarily affect the revenue and earnings of many internet and e-commerce companies, JD.com doesn't see these new measures affecting its business very much. In fact, JD could actually benefit from them.
Image source: Getty Images.
Revenue and profits beat expectations
In the second quarter, JD's net revenue increased 26.2% to $39.3 billion, which was especially impressive since the company was lapping a strong quarter last year during the onset of the pandemic. Adjusted earnings per share of $0.45 also beat analyst expectations by $0.11. Services revenue, which will likely be higher-margin than retail revenue at maturity, grew faster, up 49.2% -- another encouraging sign. And the company's trailing-12-month free cash flow surged over 40% to $4.9 billion. These strong results came on the back of a 32-million user increase over the past year, bringing JD's user base to around 532 million.
Overall, it was a solid quarter for JD.com, with growth across its various segments, from its first-person and third-party retail mall to its advertising and logistics platforms.
How JD.com may actually benefit from new regulations
While "Chinese tech" tends to get lumped together, it's important for investors to know how JD's business strategy differs from its peers', and why that may set it up to succeed in this new era of tighter regulations.
Unlike pure "platform" peers, which mostly utilize third parties for deliveries, JD went through the expensive and painstaking task of building out its own logistics platform across China. JD also directly hires its own delivery workers, rather than outsourcing to third-party platforms. The idea was that JD would be the site for high-quality goods, and that it would be better able to control the entire e-commerce experience due to its in-house staff, while eventually being the most efficient platform due to its owned and operated infrastructure.
Having made those heavy investments, JD seems less likely to be penalized by regulators, which may be aiming to curb excessive profits in pure "platforms" that extract abnormal profits due to monopoly or oligopoly status.
On the conference call with analysts, CFO Sandy Xu said:
JD.com is a new type of industrial enterprise that has both the traits of real economy and the digital technologies, which inherently differentiate us from the platform economy model. JD creates value along the entire industry value chain, from providing marketing and transaction technology support, delivery and aftersales services, all the way to industry upstream of warehousing, inventory management, product selection, pricing and manufacturing. By opening up our various capabilities accumulated over years to the real economy, offering one-stop selection -- one-stop solutions and continuously enhancing supply chain efficiency, we can truly achieve a nonzero-sum value co-creation with our users and business partners.
Although the Chinese government has recently clamped down on delivery companies, especially food delivery companies, for paying their contractors a low wage, JD counts its delivery workers as full-time employees with access to the company's social and housing funds, along with accident insurance. That should also keep it in good stead with government officials during this crackdown.
Recent regulations in China take aim at e-commerce platforms. Image source: Getty Images.
How regulations could help JD
Given its model, JD should see a relative benefit from new regulations, which may harm its rivals to a greater extent. For instance, if JD's rival e-commerce platforms, or their third-party logistics partners, have to begin paying their delivery drivers more or increase their benefits, JD could benefit from better relative costs and prices to the consumer.
Second, JD has long had a disadvantage in the marketplace due to rival Alibaba Group Holding's (BABA 0.61%) forcing brands into exclusivity contracts to access its leading platform. The practice is known in China as "pick one of two." This is one of the key practices on which the government is now clamping down. Chinese regulators are now effectively banning this practice, which has kept some big-name brands off of JD's platform. On the conference call, JD's management noted that as a result of the elimination of this practice, brands such as Starbucks and Estée Lauder returned to JD's platform in the second quarter.
Third, JD has also been the victim of aggressive subsidies by rivals, particularly the low-cost insurgent Pinduoduo (PDD +0.38%), a group-buying discount site that has gone from zero to 738.5 million users in just six years of existence. That has come with a healthy dose of market-distorting discounts in order to bring in users. While Pinduoduo's growth has been impressive, the regulatory crackdown on market-distorting subsidies could also help even the playing field on price, and consumers may now steer toward the highest-quality experience, which could very well be JD.com.
Basically, these new regulations aim to shape the Chinese tech economy toward a more high-quality experience, for which JD has been strategizing all along. Since its rivals appear to be more affected by these new rules, JD should benefit on a relative basis. Down about 30% from all-time highs and trading at just 23.6 times trailing free cash flow, the stock sure looks like a good value, should it be able to keep up this level of growth.
