Finely made

Why did the chicken cross the road? It is one of the best-known jokes in the English language and even small children can readily provide the answer: because it wanted to get to the other side.

But where did the chicken come from? Where is it going? What kind of eggs does it lay?

These are the kind of answers that one of China’s biggest e-commerce and logistics companies hopes to offer over the next decade. These are no trivia. Last month, JD.com even partnered with Walmart, IBM and China’s elite college Tsinghua University to use blockchain technology to devise standards and systems that will track food from farm to fork.

Provenance is becoming hugely important in a country like China where consumers are always nervous about adulterated products. It has also long been close to the heart of JD.com founder, Richard Liu. It is what he frequently and very publicly highlights as the main distinguishing feature between his platform and that of rival, Jack Ma’s.

JD.com knows the provenance of its goods because unlike Alibaba’s model it owns its inventory and controls the supply chain. It has cost the company dear in terms of profits since it was founded two-decades ago, but it does mean JD.com has been able to keep fakes off its site. By contrast, Alibaba has built a highly successful and more profitable asset-light model that has not done anywhere near so well in controlling counterfeited products sold by independent vendors on Tmall.

Provenance and logistics may be two of the key features that unlock growth at JD.com as it continues to fight its way out of Alibaba’s shadow. Since 2014, the duo has squeezed out smaller online shopping platforms. As a result, its market share has risen from 17.7% to 32.9% as of mid-2017 compared to Tmall’s growth from 51.3% to 54.6% over the same period.

Where Alibaba has diversified into multiple businesses in recent years, JD.com has largely stayed true to its roots as an e-commerce platform backed by a logistics arm, a fintech arm and more recently AI and cloud computing operations that will boost its data analytics and in future deliveries ‘peopled’ by drones and autonomous vehicles.

In one important respect, JD.com has already surpassed Alibaba. At roughly 58 times forecast 2018 price-to-earnings, it is the most expensive of the major 16 Chinese internet-related stocks (which average around the 26 times forward earnings). Alibaba is currently trading around less than half JD.com’s valuation at 25 times.

One reason for this disparity is JD.com’s low profitability. Like Amazon, it continuously ploughs revenues back into the company to create scale and has only been profitable for four quarters during its entire history. Two of these were back in 2013, when it only just broke even.

But the two most recent profitable quarters occurred during 2017 and analysts believe JD.com may now have built enough scale to stay profitable. During the third quarter, it massively exceeded analysts’ expectations, generating net income of Rmb1 billion ($150 million).

The other major reason why there is such a valuation gap between JD.com and its peers is because analysts have high expectations for earnings growth from 2019 to 2021. Net income is forecast to grow by around 58% over the three years compared to 26% at Alibaba. In turn, this should help contract JD.com’s high forward earnings multiple.

On a price to sales basis, JD.com ranks far below the average at just 1 times forward sales compared to 8.6 times for those 16 internet-related stocks including the BAT troika.

At the end of 2017, JD.com finally achieved 100% coverage of Chinese counties and villages for its distribution network. The next step is to bring delivery costs down using unmanned vehicles and drones.

In the US, Amazon has been handicapped by regulations, which do not allow drones to be flown out of an operator’s sight. As a result, the group has been instead testing its drone capability in the UK where it has been building up its operations in Cambridge.

JD.com has not been handicapped by the same kind of restrictions in China where it has been testing commercial drone delivery in numerous provinces, starting with Jiangsu in 2015. The test sites also now cover Beijing, Guizhou, Sichuan and Shanxi.

In December, the group entered a strategic partnership with Guangdong Longhao Aviation Group to develop its drone logistics platform including airport construction, flight training and airspace control. It also has a partnership with Northwestern Polytechnical University to develop drones that can carry loads of up to one tonne.

Drone delivery should be particularly effective for remoter rural areas where ‘last mile’ delivery by vehicles is prohibitively expensive. The group says it already has deliverymen based in every Chinese village. It aims to drop packages to them, which will then be hand delivered. It is piloting the programme in Shanxi.

If JD.com has its way, the province will also make history as the place where the world’s first urban drone delivery platform becomes operational: in Hangcheng where it has signed a co-operation agreement with the municipal government.

At ground level, its famous red three-wheeled scooters are also likely to be replaced by autonomous delivery vehicles in short order. After initially testing unmanned autonomous vehicles at various universities across China, a prototype hit the streets of Tianjin for the first time this January.

JD.com’s logistics arm is one of its crown jewels and in April last year, it was split out of the main group in preparation for a listing, potentially joining a half dozen other express delivery companies which are already listed including SF Express and ZTO Express (the likelihood is it will dual list in Hong Kong and the A-share market). Reuters recently reported the group is worth $10 billion based on its ongoing fundraising round, which is being supported by Hillhouse and Sequoia Capital.

Earlier this year, Liu also announced a new structure, splitting JD.com into three main businesses: Fast Moving Consumer Goods (FMCG) and B2B supply chain solutions; electrical appliances and JD Global (its international platform); and fashion and lifestyle. Each new group gets a vice president reporting directly to Liu, freeing him to concentrate on long-term planning.

In a newer strategy the firm now sells its own-branded goods – the new line is called Jingzao, which is a punt on its name Jingdong while carrying a double meaning of “finely made”

The new brand will focus on what is termed the ‘normcore’ segment (normal looking clothes) and soft furnishings with natural hues. Likewise its new grocery initiative saw its first 7Fresh smart supermarket open in Beijing this month.

Liu also made a trip to Davos this week to raise his profile. He told attendees that JD.com was named after his first love (she was called Jing) and said his long term goal was to sell “superior Chinese brands” in overseas markets. As per this plan he said has targeted Southeast Asia first (JD.com has local language sites in Indonesia and Thailand and earlier this month bought a Vietnamese e-commerce company).

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