Chinese e-commerce giant JD.com (JD 0.65%) just reported a blowout second quarter. Revenue hit a record 254 billion yuan (roughly $39.3 billion), beating analysts' consensus expectation. The company also added 32 million net new annual active customers -- the most ever in a single quarter -- bringing its user base to 532 million names.
The earnings release also offered some insights into JD.com's operational performance, as well as what could lie ahead for the company.
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Another quarter of solid growth
In the first quarter, JD.com's revenue grew 39% year over year. The company sustained its momentum through Q2, with revenue growing 26%. Breaking it down further, product revenue rose 23% to 219.7 billion yuan. Its services segment -- which includes healthcare, logistics, and advertising businesses -- continued to scale rapidly, notching a 49% top-line increase.
However, non-GAAP income fell by 55% year over year to 2.5 billion yuan ($400 million) as higher operating costs offset revenue gains. The operating margin for JD.com's core e-commerce business remained at 2.6%, nearly unchanged from a year ago.
Much of JD.com's strong performance was driven by its online retail division. Its expansion into China's lower-tier cities is paying off, supercharging customer growth. Of the 32 million users it added during the quarter, 80% were from lower-tier cities.
Moreover, the adoption of the company's Amazon (NASDAQ: AMZN) Prime-like membership program -- JD Plus -- accelerated throughout the quarter. Adding lots of customers is great but getting more of them to pay up for a loyalty subscription is even better for the bottom line. The number of paying JD Plus members rose 30% year over year, expanding even faster than its overall user base.
More importantly, JD Plus's average revenue per user grew during the quarter. JD Plus members are now spending on average at least nine times more than non-Plus members. This suggests engagement levels are increasing. As long as JD.com keeps building a sticky customer base through JD Plus, it can sustain the growth of its e-commerce business.
A robust cash flow machine
Like Amazon, JD.com earns most of its revenue from first-party online sales. The direct e-commerce model gives it greater control over the end-to-end shopping experience. For instance, by purchasing its own inventory, the e-tailer ensures it sells only quality products on its platform. That's great for customers but comes with obvious downsides. Direct selling is capital-intensive and comes with high fixed costs ranging from warehousing to staff salaries.
As a result of those costs, JD.com operated at a loss for most of its history. But as it grew to become China's biggest retailer by revenue, it benefited from ever-expanding economies of scale and increasing operating leverage. In 2019, JD.com delivered an annual profit for the first time. It has been profitable ever since.
Along the way, it has morphed into a cash-flow machine. In the 12-month period ending July 30, JD.com generated free cash flows of 31.9 billion yuan -- up from 13.5 billion yuan in 2016. This gives it the fuel it needs to power fast-growing new businesses such as JD Health and JD Logistics. Its non-e-commerce businesses grew revenue by 72% in the second quarter, far outpacing its overall growth rate of 39%. As it continues to nurture and scale these businesses, it can count on sustained growth for years to come.
Dealing with regulatory challenges
The last few months have been a roller-coaster ride for investors in Chinese companies. China's government has launched a sweeping crackdown on a wide range of industries, citing -- among other things -- data security and antitrust concerns.
While JD.com has not been singled out by regulators over any of these issues, investors are still nervous -- and understandably so. After all, Chinese authorities seem to have trained their guns on that nation's largest tech companies, such as Alibaba and DiDi Global. JD.com is a member of this exclusive club.
Call it wishful thinking, but the company's executives expect it to emerge relatively unscathed. Speaking to analysts on Aug. 23, JD Retail CEO Xu Lei said China's new regulations are not -- as some investors fear -- "intended to restrict or suppress the Internet and relevant industries." Instead, China aims to create "a fair and orderly business environment and to promote long-term and sustainable development of these industries," Lei said.
Unlike most tech-driven platforms that mainly act as middlemen between buyers and sellers, JD.com has a tangible presence in many parts of China's economy. It operates tens of thousands of brick-and-mortar stores across the country, and has 23 million square meters of warehouse space.
Moreover, it directly employs 400,000 people across its many business units. Its express delivery workers have formal employment contracts -- something Uber and others have come under fire for failing to offer. These "social value" and "real economy" traits set JD.com apart from pure platform operators that "reap ultra-high profits out of traffic and transaction flow," Lei said.
All in all, JD.com believes it is firmly on the same page with the Chinese government and will continue to grow over the longer term.
Foolish takeaway
While JD.com's latest results are impressive, there is much to suggest it has plenty of room for further growth. And its online retail business continues to generate plenty of cash flow, giving it the fuel it needs to feed that growth.
The cloud of regulatory uncertainty surrounding JD.com will continue to weigh on its near-term outlook. But the company appears to have aligned itself with the Chinese government's long-term goals. In the long run, this could prove to be a smart strategy.
