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March 4, 2015 Mariano R. Viola Internet Sector Analyst (917) 751-‐3733 [email protected] www.violaadvisory.com 4Q14 China E-‐commerce: BABA, JD and VIPS Viola Advisory 4Q14 China E-‐commerce Price Target and Ratings BABA JD VIPS Price Target $100 $35 $30 Rating BUY BUY BUY Still Bullish on China E-‐commerce: We view Mobile Online Shopping as Positive Catalyst; Attractive Valuations on BABA and VIPS. I.
Earnings Performance TABLE 1: Earnings Performance and 1Q15 Guidance 4Q14 Results EPS 1Q15 Guidance Cons. Result EPS Cons. BABA $0.81 $0.75 JD 0.01 -‐0.02 VIPS 0.12 0.09 beat -‐-‐ RMB 2.82 beat n/a beat -‐-‐ 4Q14 Results 1Q15 Guidance Result Total Rev. Cons. Result Total Rev. miss Cons. Result n/a $4.22B $4.45B -‐-‐ RMB 17.40B n/a -‐0.01 n/a 5.60B 5.30B beat 5.55-‐5.71B 5.60B beat 0.08 n/a 1.36B 1.23B beat 1.25-‐1.30B 1.22B beat Source: Company announcements Alibaba Group – Short-‐Term Outlook: Positive Alibaba reported 4Q non-‐GAAP earnings per share of $0.81 beating the analysts' expectations of $0.75. Revenue for the quarter was $4.22B (up 40% y/y) missing analysts' expectations of $4.45B, causing the stock to decline 11.3% at market open and to end down 8.8% at market close. Non-‐GAAP net income increased by 25% y/y to RMB 13.1B but GAAP net income fell 28% y/y to RMB 5.98B due to 1) an increase in share-‐based compensation expense, 2) a RMB 830M one-‐time charge for financing-‐related fees, and 3) an increase in income tax expense. Customer base showed significant growth as annual active buyers reached 334M in 4Q14, up 45% y/y and 9% q/q. Mobile MAU increased by 48M sequentially and 95% y/y to reach 265M. Other key takeaways include: • Mobile Sales and Monetization Grew Rapidly. Quarterly GMV transacted on China retail marketplaces reached RMB 787B, up 49% y/y and 42% q/q, due to an increase in active buyers and partially to category expansion like auction transactions. o Taobao Marketplace contributed RMB 494B or 63% of the total China retail marketplaces GMV; o Tmall contributed RMB 293B or 37%, compared with 32% in 3Q14. CONFIDENTIAL
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VIOLA ADVISORY, LLC 03/04/15 Mobile GMV grew 213% y/y to RMB 327B, accounting for 42% of total GMV, vs. 36% in 3Q14 and 20% in 4Q13. Mobile monetization rate increased to 1.96% from 1.87% in 3Q14 and 1.12% in 4Q13. The increase was mainly due to higher mobile traffic as well as changes in buyers’ purchase behavior. •
Lower Monetization Rate Could Impact Near-‐term Online Marketing Revenue. Blended monetization rate for the China Commerce Retail business of 2.7% was lower from 3.05% a year ago due to a larger percentage of GMV coming from mobile, which had a lower monetization rate and the introduction of personalized search in June 2014, which have lower CPCs. We believe that search ads account for around 35-‐40% of Alibaba’s total revenue in 4Q14 so the growth rate of online marketing revenue may be negatively affected by the lower monetization rate in the short run. •
Zero Tolerance for Counterfeiting. Management disclosed that over the past 2 years, it invested over RMB 1B and hired over 1,000 employees to combat counterfeit products. Management reiterated that it values integrity and the health of the marketplace and will continue to work with the government and brand owners as well as apply data technology to fight against counterfeiting. We like Alibaba’s long-‐term value proposition as it expands to new categories like pharmaceuticals and digital entertainment and its cloud business expands rapidly. We are not so concerned about the near-‐
term pressure on online marketing revenue growth on the PC side and its monetization rate. Alibaba’s current situation is similar to that of Baidu in 1H13, when the initial monetization of mobile traffic led to an increase in paid clicks at much lower pricing than PC. We think Alibaba’s ad monetization could follow the same trajectory as Baidu in their later mobile monetization stage to enjoy robust revenue growth driven by paid clicks and pricing. Alibaba remains one of our favorite large-‐cap name in the China Internet space. We reiterate our Buy rating but we are lowering our PT from $120 to $100 to reflect lower online marketing revenue. JD.com – Short-‐Term Outlook: Positive JD.com reported 4Q14 EPS of $0.01 beating consensus by $0.03 and revenue of $5.6B beating consensus of $5.3B. Management guided 1Q15 revenue at a range of $5.55B-‐5.71B (+54-‐58% y/y) slightly above $5.6B consensus at the midpoint. Other highlights include: -‐ GMV increased 119% y/y in 4Q to $13.8B, slightly higher from 3Q's 111% growth. Annual active customer accounts grew 104% y/y to 96.6M. -‐ Fulfilled orders increased 95% y/y to 217.8M with 36% of fulfilled orders from mobile, up from 29.6% in 3Q. -‐ Direct sales was up 67% y/y to $5.22B and services/other revenue +199% to $377M. -‐ JD spent heavily on its warehouses and logistics infrastructure to differentiate itself; fulfillment spend grew 107% to $400M. Marketing spend was also up 121% to $200M, tech/content spend increased 124% to $100M and G&A spend grew 63% to $56M. -‐ Gross margin in 4Q increased to 12.6% from 12.2% in 3Q and from 10.1% in 4Q13. 2014 free cash flow was $139.4M and was largely held down by heavy spending. CONFIDENTIAL 2 VIOLA ADVISORY, LLC 03/04/15 Apparel Outperformed and Core Categories Grew Rapidly in 4Q14. According to EnfoDesk, 4Q14 sales of JD’s apparel and baby & maternity products were up 331% and 51% y/y respectively. The growth rate of JD’s apparel business beat the sector average of 52% as well as Alibaba’s Tmall of 57%. JD’s market share also increased to 6% from 5.5% in 3Q14 with 3C (computers, communications and consumer electronics) and general merchandise expected to account for 57% and 43% of total GMV in 2014. We think JD has gained scale advantages for 3C categories (4Q14 market share was 32% vs 43% of Tmall). Furthermore, we believe that its marketplace expansion will accelerate and gross margin will further expand in 2015. JD has also entered the online automobile market by investing in Bitauto.com (BITA) and expanding its categories by introducing food from overseas markets. Revenue from Services will be Key to Future Growth. Gross margin of direct sales (e.g. 6% for 3C) was lower than services (marketplace commissions, ads, logistics and Internet finance) which we believe will be the major drivers for future profit. Revenue from services is expected to grow to 12.6% in 2016 from 5.7% in 2014. Logistics services are the last-‐mile delivery service for third parties and JD is expected to provide warehouse services to third parties beginning 1H15. Additionally, 2014 product crowd funding of Internet finance reached RMB 140M and JD is also expected to tap into equity crowd funding beginning in 2Q15. Limited Headline Risk. The Wall Street Journal came out with an article (3/3/15) which discussed the practice of merchants faking orders as a problem currently facing Alibaba, which has 80% of China’s e-‐
commerce market. We believe this issue is unique to Alibaba because the company hosts third-‐party merchants on its platforms but does not carry their inventory. In contrast, e-‐commerce companies like JD.com and Vipshop will not likely experience this problem on the same scale as Alibaba because they carry inventories for their third-‐party merchants and can therefore monitor the transactions more closely. We are optimistic that JD’s unique differentiation and increasing scale in the e-‐commerce space gives it the potential to grow margins and possibly outperform expectations in 2015. We rate JD a Buy with a $35 PT. Vipshop Holdings – Short-‐Term Outlook: Positive Vipshop reported 4Q EPS of $0.12 beating consensus by $0.03 and revenue of $1.36B (+108.9% y/y) beating consensus of $1.23B. 1Q15 revenue guidance of $1.25-‐1.30B also came in strong beating consensus of $1.22B. We believe VIPS will be a story of top-‐line revenue growth in the short run as revenue continues to be driven mainly by increases in the number of total active customers (+114.2% in 4Q) and an increase in the number of total orders (+99.6% in 4Q). Large Scalable Platform Enables Strong Operating Leverage. VIPS’s large scale has been driven by improvements in its average order size (+15% in 4Q vs. 12% in FY2012 and FY2013) and the strong increase in active customers (almost 17M added in 2014, a 150% increase from last year). This scalability enabled strong operating leverage in 4Q as marketing expenses grew 46% but decreased as a percent of total revenue from 5.2% in 3Q to 5.0% in 4Q. Similarly, G&A expenses grew by 41% in 4Q but decreased as a percent of total revenue from 3.2% in 3Q to 2.9% in 4Q. Investments in Warehouses and Logistics Builds Customer Loyalty and Barriers to Entry. Management stated that as of 2014, VIPS’s last mile infrastructure supported around 50% of total orders and by end of 2015, the company plans on covering 70% of order volume with last mile delivery. We believe investments in logistics creates a positive user experience which drives repeat purchases. Management stated that the repeat purchase rate in 4Q was almost 60%. Moreover, order delivery in China tends to CONFIDENTIAL 3 VIOLA ADVISORY, LLC 03/04/15 be inefficient, especially in the urban centers. So e-‐commerce companies with a reputation for fast and efficient local delivery service will go a long way in building high-‐entry barriers and a competitive advantage. Is VIPS Growth Already Priced into the Stock Price? We believe that mobile growth could be the next catalyst for upside in the stock price. Enfodesk estimated the number of mobile shoppers in China reached over 300M in 2014, a 35% y/y growth outpacing the 25% growth of PC online shoppers. In 2014, almost 53% of VIPS’ GMV came from mobile devices and in 4Q14, mobile GMV was nearly 66%. We believe that as mobile continues to drive e-‐commerce in China, VIPS’s flash sale model, which offers daily sales events on popular brands in limited quantities for a limited time period, could enjoy strong growth momentum heading into 2015. We rate VIPS with a Buy rating and a $30 PT. II.
Market Sentiment Market sentiment is overwhelmingly positive for both BABA and VIPS and neutral for JD. Among the analysts covering BABA, 35 rate it a Buy while only 5 rate it a Hold (see Table 2). This gives it a Buy to Hold ratio of 7 to 1. We usually interpret a Buy-‐Hold ratio of at least 2:1 as a positive indicator of market sentiment. Similarly, 20 analysts covering VIPS rate it a Buy while 5 rate it a Hold, giving it a Buy-‐to-‐Hold ratio of 4.0 to 1 while 17 analysts rate JD a Buy and 9 rate it a Hold, giving the company a Buy-‐Hold ratio of 1.89 to 1. TABLE 2: Analyst Coverage and Earnings Scorecard Analyst Coverage Past Surprise -‐ 1Q15 Mkt. VA Buy/Hold/Sell EPS -‐ GAAP Sales PT PT 35/5/2 -‐-‐ -‐-‐ $ 111 $ 100 JD 17/9/1 -‐-‐ -‐-‐ $ 33 $ 35 VIPS 20/5/0 Beat 7 of 8 Beat 8 of 8 $ 28 $ 30 BABA Source: Bloomberg Market Confidence on Price Target BABA. Alibaba at this point does not have a previous track record that covers 1Q EPS and Sales. The company also does not provide forward guidance which leads to increased stock price volatility around earnings dates. Despite the lack of near-‐term visibility, we are comfortable with our $100 PT. Since the 4Q14 earnings report, nothing fundamentally has changed with Alibaba except sentiment. The company still has a commanding share of the Chinese e-‐commerce market and as GDP per capita and Internet penetration in China continue to increase going forward, so too might Alibaba’s valuation. VIPS. VIPS has a track record of beating 1Q sales estimates 8 out of 8 times and beating EPS estimates 7 out of 8 times. Given that management has executed well in the past and that online flash sales is forecasted to grow by around 50% y/y in 2015, we are comfortable with our $30 price target which is slightly above the $28 market PT. JD. JD.com has consistently beaten EPS estimates for the last 3 quarters and 1Q15 revenue estimate of $5.6B equates 1Q sales growth at 51.0% compared to the prior year period. We think given the late start to this year’s Chinese New Year, the company has a good chance of meeting or beating its revenue estimates but we think JD could miss EPS estimates due to high levels of operating expenses. We think CONFIDENTIAL 4 VIOLA ADVISORY, LLC 03/04/15 the market views JD as a growth story and we are comfortable with our $35 PT which is slightly higher than the average market PT of $33. III.
Valuation We believe both BABA and VIPS have reasonable valuations given their top-‐line growth projections for 2016. Fwd P/E for both BABA and VIPS are trading near their 1-‐yr. average Fwd P/E indicating fair value (see Table 3). But from a PEG valuation, we think VIPS is relatively cheap trading at roughly half the valuation of BABA. Given that JD has been sustaining losses, Fwd P/E is not a good valuation metric. The market is valuing JD on top-‐line growth and with 2016 revenue growth at 38% y/y, we believe BABA or VIPS may be a better investment at this time. TABLE 3: Forward Valuation and Next Year Growth Rates BABA 1-‐Yr Avg. rich/ 2016 EPS 2016 Rev. Fwd P/E Fwd P/E cheap PEG Growth % Growth % 32.99 36.80 0.9 1.09 30% 36% JD 312.91 2543.02 0.1 0.75 420% 38% VIPS 46.42 48.42 1.0 0.58 57% 47% Source: Bloomberg CONFIDENTIAL 5 VIOLA ADVISORY, LLC 03/04/15 Disclosure Information
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