Venture: China Internet

Issue 25;

I am exploring the holdings within EMQQ and will highlight the best opportunities I can find. The focus is on companies displaying value and growth, and easily accessible by international investors, which normally means there is a US listing.

JD.COM (JD USA, 9618 HK)

“JD.com is a leading supply chain-based technology and service provider. The company’s cutting-edge retail infrastructure seeks to enable consumers to buy whatever they want, whenever and wherever they want it. The company has opened its technology and infrastructure to partners, brands and other sectors, as part of its Retail as a Service offering to help drive productivity and innovation across a range of industries.”

Some people describe JD as China’s Amazon, but JD is mainly focused on retail and logistics. That said, JD has disclosed listed stakes in JD Health, Dada Nexus, and Yixin Group, currently worth $7.8 billion.

The investment case is straight forward. This a growing company with an enterprise value of $25.3 billion, well below the market cap of $44.8 billion. You get there by reducing $38.1 billion of cash and adding debt and preferred shares of $18.7 billion. The underlying business has $153 billion in sales, with stable 15% gross margins, which generated $5.8 billion of free cash flow last year.

JD Enterprise Value to Sales

JD has a huge logistics network in China with 1,600 warehouses and 2,000 cloud warehouses, amounting to 32 million square metres of space. They have 40,000 trucks, 400 sorting centres, 1,000 air cargo routes, and 400 on the railways. There are 425,469 in-house delivery personnel for the last mile, 18,000 delivery stations, and 200 warehouses for bulky items, with a further 200 sorting centres. I could go on.

The point Is they have a strong market position to facilitate logistics within China for both domestic and overseas customers. They are also involved in big data and AI, with the highest R&D-to-sales ratio in the industry. There can be no doubt that JD is a first-rate company with a strong market position.

The China Discount

Chinese tech is cash-rich. For example, JD bid for the UK electronics retailer Currys (CURY), but the bid was rejected. They cannot buy foreign companies as easily as the Japanese did in the 1980s, and their valuations have been trounced by political anti-China sentiment. The solution that seems to be unfolding by companies in a similar position is share buybacks. JD announced their intentions to buy back two weeks ago.

JD Share Price and Earnings

As a business operating in China, I don’t think there’s anything wrong with JD, although the share price would have you believe a crisis was underway. This is true for many Chinese stocks regardless of fundamentals. The bull case is that peak fear is behind us.

The valuation discount is largely due to geopolitics and perceptions in the West. We know the Chinese reopening post-pandemic has been sluggish. Then there were the business and corruption scandals, which the market digested. There has also been a property crash, with several defaults and bankruptcies to prove it.

Hang Seng Property Index Retests the Credit Crisis

Perhaps less known is that second, third and more homes in China are not financed by debt. The leverage is sat with the developers, not the public. There is a large pile of government debt and regional debt, but that’s another matter.  

From the investor’s perspective, I think this next chart says it all. Emerging markets were hugely popular with investors in the noughties. That popularity has been waning, and since China became a “risk”, the emerging markets ETFs have been sold for emerging markets ex-China.

I show the iShares EEM and EMXC ETFs. EEM held $50 billion of assets in 2012 and today, $17 billion. EMXC was only launched in 2017, which indicates that frictions, and therefore investor concerns, would have kicked off a couple of years earlier in 2015, witnessed by the August CNY mini-devaluation. EMXC has nearly caught up with EEM, which was one of the largest and most popular ETFs a decade ago.

EM Ex-China Has Nearly Caught up with EM

Some of the chart above is down to flows, but it has also been influenced by investment performance. EM has been sluggish in recent years, and so I show the flows below. Looking at the number of shares in issue, the persistent outflows from EM (China) become clearer, as does the rapid growth of EMXC (no China).

The Flows Have Been Decisive

I will be highlighting various stocks inspired by the recent EMQQ recommendation, and I think it’s important that investors make their mind up on China, because the risks are largely political. The risk of a Russia-style asset confiscation is in my opinion, a low risk. China hasn’t gone to war, and while there are disagreements over trade, it’s a dynamic capitalist economy, that is managed by a dictator. The West fear China’s success.

I would also highlight another thing: these Chinese stocks appear in very few indices and ETFs, making EMQQ a notable exception. They are featured in Hong Kong’s Hang Seng Index, but here’s the thing: there is no Hang Seng ETF in Europe, and EWH in the US has seen outflows of 82%. China and Hong Kong are massively under-owned by international investors.

Going back to JD, the shares trade on 9x 2024 earnings, and there is a 2.6% dividend yield. The free cash flow yield is 12%, which is close to its all-time high. The shares are 10% owned by Walmart (WMT) and, in my opinion, are undervalued.

Risk

The greatest risk is the China risk. If you agree with that, every investment in China is high risk. However, if you think China is a more normal risk from an investment perspective, then all is well. Recall that JD is listed in the USA and has been for 10 years, and there is no call for that to change. JD is profitable, with a strong balance sheet, and is highly liquid. I deem it to be medium to high risk.

Venture Update

Smiths News (SNWS) reported positive results. The refinancing enables higher dividend payouts and the potential for buybacks. A very nice income stock.

Please let me know your thoughts by emailing me at charlie.morris@bytetree.com or tweeting me @AtlasPulse.

Many thanks,

Charlie Morris

Editor, Venture