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Is Michael Burry Wrong About JD.com?

5/25/2023

 
Michael Burry is as close as it gets to a stock market celebrity. Investors like to follow his every move. The always-pessimistic investor has earned the right to his celebrity status by enduring the emotional toll it takes on one's mind to go against the mainstream. His famed bet against mortgage-backed securities in 2008 made him and his clients millions. His bet on GameStop and the consecutive short-squeeze solidified his status as the dark prince of the stock market. In later 2022, he forecasted an extended multi-year recession for the U.S. economy, and now he is making big bets on China's consumer spending recovery by picking up shares of Alibaba (BABA) and JD.com (JD). 

Is he right about those Chinese stocks? Let's talk about that!
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I'm Hoda Mehr, founder, and CEO of Stock Card, and on this blog and its accompanying YouTube channel and Podcast show, I share detailed fundamental analyses and interesting investment stories.

This post is part of a series I started a few weeks ago to research companies that are down significantly from their all-time highs to decide whether to buy more or sell and allocate money to other companies. I've already researched Canopy Growth (CGC), Fastly (FSLY), Snap (SNAP) ,  Shopify (SHOP),  Airbnb (ABNB), and Unity (U). I'll continue with this series for a few more weeks.

​Remember, this content is for education and sharing ideas and not advice to buy or sell any securities. 

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Chinese stocks and whether to invest in them is a fascinating story in the market. Some hate investing in the country due to political and philosophical differences between the U.S. democratic system and China's government-controlled economy. Some prominent investors, such as Charlie Munger, who have been quite bullish about investing in companies such as Alibaba, have recently changed their minds about the company. I have discussed how I disagree with Munger in a recent episode that I recommend you watch if you are interested in Alibaba. I'll leave a link to it in the show notes.

​Today's episode is about JD.com (Ticker JD), one of the two Chinese stocks Burry has invested in based on the last 13F report for this investment management company, Scion Asset Management. 

Interestingly, one of our YouTube channel viewers has also recently requested detailed research on JD, so I'm doubly glad to spend today's episode on this company's fundamental analysis. If you have any stock ideas you'd like me to cover in the future, don't forget to share them in the comments. You never know, it can find its way to future episodes. 
​

On to JD's fundamental analysis. As always, we look at the company across six criteria: 
  1. How the company makes money,
  2. Its top and bottom line figures and margins,
  3. Noteworthy changes in the top and bottom lines,
  4. Balance sheet strength,
  5. Ability to generate cash to reinvest in its future,
  6. Current valuation and the feasibility of growing into it.

JD.com's Fundamental Analysis​

JD.com is a Chinese e-commerce company headquartered in Beijing. According to the company's website, it is the largest online retailer in China and the biggest internet company by Revenue. This is interesting because I thought Alibaba owned that title. 

JD's Topline:
The company just recently announced its earnings release report, with 243M in Chinese Yuan quarterly revenue, down 18% quarter over quarter. Not a so good start for a company to bet big on. That's certainly a red flag. But, let's not rush and understand the reasons for the decline.
The decline isn't as bad when you compare the revenue with Q12021, which is up nearly 1.5%. When you look at the revenue across all business units, JD Logistics drives growth while new businesses and retail suffer. 
We discussed this in the past when we analyzed Snap together, revenue is a lagging indicator. To see where a company is going, we must look at its leading indicators, such as daily active users. Engagement inevitably results in higher revenue if more users are active on the platform daily. JD's application saw double-digit year-on-year growth in March.
Additionally, there is a revenue mix shift. JD is focusing on moving toward more high-margin categories, such as Services, which is a segment that grew 34% in Q1. The Services refer to marketplace and advertising revenue it charges merchants and advertisers to leverage the company's platform. 

My point is that the business isn't in downward disarray. It has growing segments that will result in future revenue growth. 

Complex Organization:

While researching the company's different divisions, I came across another red flag which is the complex organizational structure of JD. As you read through the company's annual reports, it's cumbersome to understand the relationship between different divisions. Every segment of the company acts like a stand-alone company in which the broader JD has ownership interests and agreements. The CEO talked about reorganization efforts to simplify the structure, and we have seen similar efforts at Alibaba. 

A complex organization isn't bad by its nature. For example, Berkshire Hathaway is a complex organization with multiple equity ownership, full ownership, and part investments in various businesses. It just makes understanding the business harder, and that's a red flag in my books. 


JD.com's Bottom Line:
This seems to be an area the management focuses on. Even the core retail business, which has been shrinking in terms of top-line revenue, has managed to grow its profitability by almost 5% year on year. The improvement comes from cutting marketing expenses by 8% and R&D by 4.5%, with most other costs staying relatively steady.
​

It's good to see high profitability, but not good to see R&D cuts. 

JD.com's Free Cash Flow:
Profits are good, but better yet is free cash flow which is a true indicator of a business's ability to make money. Although the company didn't make free cash flow in its latest quarter, the trailing 12-month free cash flow is 19B Chinese Yuan. On a roughly 1 trillion Chines Yuan annualized revenue, 19 B free cash flow represents about 2% of free cash flow to revenue ratio, It's good to see the company makes free cash flow, but the FCF to revenue ratio isn't as impressive as I had hoped. 

JD.com's Balance Sheet:
The next point is JD's balance sheet strength. The company has some cash and some liabilities with its primary metrics, such as debt to equity, debt affordability, and current ratios, all hovering in an acceptable range. 

Summary of JD.com's Fundamental Analysis:
So let's recap JD's fundamental analysis before turning to its valuation because the company's fundamentals aren't a slam dunk as some of the other companies we have discussed in the past, which you can watch and view if you go to the "Beaten Down Stocks" playlist on our YouTube channel. However, they could all be overshadowed if we can buy JD at a good valuation.
In summary:
  1. Revenue is declining, with pockets of business experiencing accelerated growth
  2. The operations have turned more profitable thanks to cost-cutting efforts by the management
  3. The company has a stable balance sheet with no concerns
  4. It generates free cash flow, but the FCF/revenue ratio isn't impressive.

Why Did Michael Burry Invest In JD?

Knowing all that, why did Michael Burry allocate over 19% of Scion Asset Management's fund to this company?  The answer lies in the valuation:
  1. A price-to-sale ratio of 0.4 times translates to extremely negative sentiment about the company's future, which seems unreasonable. Especially if we expect Chinese consumer spending to recover in the future, the company has the force of the market recovery behind its back. 
  2. Price to earnings ratio of 21 times
  3. Forward price to earnings ratio 14 times, indicating higher expected profitability in the future

Michael Burry is making a value bet on JD's stock, most likely expecting a recovery in consumer spending in China in the years to come and understanding that the company is indeed able to grow its revenue in the future.

Also, the upside expectation isn't limited to Burry. 9 analysts who updated their JD's price target in the last six months expect an average 100% upside for the stock with 7 Buy recommendations and 2 Hold.  Knowing all that, what should we do with the shares? Should we follow the dark prince of the stock market to buy more JD's shares?

Is JD.com A Buy Now?

Buying this stock goes back to how comfortable you are with owning and holding a Chinese stock. I believe the stock is truly undervalued and has an upside. But, there is no guarantee the recovery to happen anytime soon.

If we compare JD's market cap with Alibaba, we see a 4X difference between the two. Although Alibaba gets a big valuation boost because of its cloud and mobile payment businesses, they are relatively comparable.  


I expect that JD can double my money if I'm patient enough. But I don't see the evidence that the stock can be a significant multi-bagger. You should decide if you have the patience and the interest to hold JD.com in your portfolio for a chase to double your money. 

Now it's your turn to lock up JD's Stock Card.

​See you next time!

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