JD.Com: Growth at all costs
The Chinese use the internet more frequently than what we typically do in the west. For example, I might buy a pair of sneakers from overseas once or twice a year, whereas the Chinese will buy their toothpaste and all sorts of daily goods every day. This is because they don't have 40 years’ worth of bricks and mortar retail built up around them. It's actually quite painful for a lot of people to go out on the street and go shopping, and you don't really want to spend too much outside in a place like Beijing due to the pollution levels. As a result, a company like JD provides an extremely valuable service. Delivery is fast (measured in hours not days), its still very cheap, and you get authentic goods.
It’s the world’s third-largest internet company by revenue, it’s known as the Amazon of China, and it’s growing at 40% per year. Its market cap, a modest $60 billion.
Valuation – what’s the catch?
In terms of the valuation, it’s a business where I think there’s a lack of trust. It's not trying to make as much money out of the retail business as it can, it's just trying to grow and get customers in. You don't see high reported profits, and the margins are very thin. But this isn’t new. This is straight from Amazon’s playbook 20 years ago. Growth at all costs. Before the market give it a supersized price, they want to see margins start expanding. At the moment, the founder Richard Liu is just saying, "the margins will come in the future. Right now, it's all about getting as many customers on the platform as we can and delivering exceptional service so these people want to continue to buy more and more from us every year."
You can see how valuable it is to first get people under the platform and have a good experience by looking at what happened with Amazon and their Prime Membership. When people sign up to the Prime Membership, there’s a gargantuan increase in the amount of money people spend and the number of items or times that people shop per year. At the moment, Amazon is trading at nearly four times price to sales. Just bearing in mind that Amazon is a different business because it has a very profitable data cloud storage business that JD doesn't have, but JD's only trading at about a quarter of that on the price to sales metric.
If you follow the sales growth which is about 30 or 40 percent a year, add another two or three years, you get JD trading on half times sales which makes no sense to us. We think this is one where your patience will be rewarded.
I haven't seen another portfolio that has as much insider owner or founder led businesses as what we have here. Research has shown, founder-led companies outperform. As Charles Schwab has said:
“The man who does not work for the love of work, but only for money, is likely to neither make money nor find much fun in life.’
The founder and current CEO of JD is Richard Liu. This is a man that truly loves his business. One day a year he gets on the motorbike and he goes out and does deliveries himself (this is exactly the sort of behaviour we expect from a founder led business). He wants to check that what's going on at the frontline is actually what’s really going on when he's sitting in his office. Now, this does worry us because if you've seen the traffic in China, you really don't want this guy out on the motorbike too often. But, it actually shows how much he loves his business and how much he cares about his customers which is what we think is the competitive advantage.
This article has been transcribed from the Peters MacGregor Global Investing podcast. For more podcast episodes click here