Analysts

Cheryl Gan Analyst, Consumer team gan.cheryl@gmail.com

Guo Yanchao Analyst, Consumer team

guoyanchao@u.nus.edu

Li Er Analyst, Consumer team liear96@gmail.com

Shawn Phang Analyst, Consumer team shaunphang12345@gmail.com

Basic Information Last Closed Price US$41.67 12M Target Price US$44.80 +/- Potential -11.2% Bloomberg Ticker JD.Com

1Y Price Index

Company Description JD.com, Inc. is a leading online direct sales company based in China. The Company engages in the sale of electronics and home appliance products and general merchandise products (including audio, video products and books) sourced from manufacturers, distributors and publishers in China through its website and mobile application. It also offers an online marketplace that enables third-party sellers to sell their products to customers.

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Rising Underdog of China’s E-Commerce

We are initiating coverage of JD.Com with a Buy rating and a $44.80 12M price target.

2Q17 Earnings Review Multiple factors causes weak 2Q GM; remain positive on full-

year margin expansion. The company’s non-GAAP GM was 13.4%

in 2Q, down by 2.4ppts QoQ, which was mainly due to 1) aggressive

promotion on 6.18 event, 2) product mix biased to low-margin 1P

business in promotional season, and 3) the reclassification of third-

party-related logistic costs from fulfillment expense to COGS (some

1ppt impact on GM while no impact on OPM). We remain positive

on its full-year margin expansion pace driven by the scale effect and

improving operating efficiency. We expect the net margin to expand

0.9ppts YoY in 2017 to 1.3%.

Investment Thesis 1. Portfolio expansion; JD.com is entering the high-end market to

tap on the accelerating mainland luxury goods market that will

grow by more than 4% this year. The 500mm JV with Central

Group in Thailand will become a key revenue driver and a

regional hub to service SEA.

2. Reorganization of internal units; spinoff of loss-making JD

Finance and the reclassification of JD Logistics as its own

business unit. The new money from the sale will help JD

strengthen its core e-commerce business and improve EBITDA

margins while JD Logistics’ 3rd party services will drive revenue

growth.

3. Strategic Partnerships; By leveraging on user data from major

online platforms Tencent, Toutiao and Baidu, JD will be able to

better execute brand and product marketing and boost revenue

through targeted sales.

Catalysts

a. Rising incomes of middle-class population

Rising disposable income is expected to drive demand for household

products and electronics in the both physical and online retail space.

Disposable income per capita in China has been increasing at an 11%

annual pace since 2010, alongside a swelling middle class, causing

consumption expenditure to increase.

b. Increasing focus on logistics efficiency to tap into lower-tier cities

Efficient logistics remain an important tool for e-commerce companies to

reach more consumers in different regions in a shorter time. China’s two

largest e-commerce giants Alibaba and JD.com have committed nearly

US$330 million to strengthening their parcel delivery efficiency.

Additionally, in April, JD.com announced the creation of a new business

unit, JD logistics, vowing to invest further in automated warehouses and

drone delivery to improve efficiency.

Equity Research Department 23 October 2016

JD.com BUY: US$44.80 (+11.2%)

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Key Financials

c. Increased mobile usage and Internet penetration

China’s internet penetration, at 54.3% of total population, has risen 1.1

percentage points from 2016, giving a total of 700 million plus Internet

users in China. China has also seen rapid increase in the usage of

smartphones for online shopping and payments over the past five years.

Some 63% and 68% of Chinese consumers surveyed use their mobile

phones for online shopping and online payment respectively.

Valuations The 12 month target price from the date of coverage is USD $44.80,

representing 11.1% upside. Long-term growth rate is given a very

conservative 0.6%, and the exit multiple stands at 5.4X.

Given that JD.com has reached a watershed year in 2017 as key figures

turn positive, and new market strategy and partnerships will continue

providing firm support to the P&L, we tend to give higher weightage to

the DCF valuation method and focus on the intrinsic valuation of the

entity.

Investment Risks • Expensive valuations currently given the strong share performance in

the past 12 months period

• Potential consolidation play via M&A leading to larger market share

and subsequently higher valuations.

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Figure 1. Non-GAAP net margin

Source: Annual Report 2016, Bloomberg Figure 2. JD.Com online storefront

Source: JD.Com Figure 3. GMV Evolution

Source: Company data, NUS Invest estimates

Investment Rationale

• Multiple factors causes weak 2Q GM; remain positive on full-year

margin expansion. The company’s non-GAAP GM was 13.4% in 2Q,

down by 2.4ppts QoQ, which was mainly due to 1) aggressive promotion

on 6.18 event, 2) product mix biased to low-margin 1P business in

promotional season, and 3) the reclassification of third-party-related

logistic costs from fulfillment expense to COGS (some 1ppt impact on

GM while no impact on OPM). We remain positive on its full-year

margin expansion pace driven by the scale effect and improving operating

efficiency. We expect the net margin to expand 0.9ppts YoY in 2017 to

1.3%.

• Strong GMV/topline growth with robust metrics. JD’s 2Q

GMV/revenue increased by 44%/46% YoY, beating JPMe by 5%/4%.

TTM active buyers grew by 37% YoY to 258.3m in 2Q, with

quarterly fulfilled orders increasing by 41% YoY to 591.2m. Average

order size saw continued mild expansion (+4%YoY/+3%QoQ),

implying strong stickiness of the platform.

• Maintain OW and raise our PT to US$55. As we raise our free cash

flow forecasts and extend our timeframe to Jun-18 from Dec-17, our

PT increases to US$55. Key assumptions in our DCF valuation are:

(1) a risk-free rate of 3.5%; (2) an equity risk premium of 6.5% in the

China market; (3) a beta of 1.3; (4) a discount rate of 11.2%; and (5) a

terminal growth rate of 3%.

Earnings Review

We expect that JD’s 2Q17 revenue will reach RMB91.8 bn, up 40.6%

YoY, above the upper level of its guidance. We expect its non GAAP net

income to reach RMB869 mn as JD still wants to increase its marketing

spending to gain a larger market share. Our FY17 non GAAP net profit

margin assumption has been adjusted to 1.3%.

Key points: 1) China e-commerce 2Q17 performance was above

expectation. In 2Q17, China e-commerce GMV reached RMB1,702.8 bn,

up 34.5% yoy, up 2.4 ppt qoq. In 2Q17, China’s express industry revenue

reached RMB119.7 bn, up 27.1% yoy, with delivered packages of 9.7 bn,

up 30.0% yoy. 2) JD Home has great upside potential. In 2Q17, Sun Art

(06808 HK) announced a venture with JD Home, while Wal-Mart opened

flagship stores through the JD app. Currently, JD Home has operations in

20 cities and has gained support from the 3 of the largest 5 hypermarkets.

Currently, JD Home has a light asset business model like Instcart and has

been expanding much faster than Tmall Supermarket.

Raise Target Price to USD50.00 and upgrade investment rating to

“Accumulate”. JD needs to continue to significantly raise its earnings.

Our FY17-FY19 non GAAP net income forecasts are RMB4,624 mn,

RMB10,630 mn, and RMB16,194 mn. Our TP is set at USD50.00,

representing 1.1x 2018E PS.

Industry description and Investment risk

Competition – China’s e-commerce industry remains highly competitive.

Not only does JD compete with established companies such as Alibaba

(BABA, Buy, PT $128), Suning (002024.SH, not covered), and Gome

(0493.HK, not covered), but it also faces competition from many newly

emerged companies in different categories such as apparel, grocery, cross-

border, etc. With expansion into logistics services it also competes with

logistics services providers. These challenges may cause JD to post lower-

than-expected GMV and/or revenue growth, and thus

impede its achieving its price target.

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Figure 3. Fulfilment cost as part of revenue

Source: Company data, NUS Invest estimates

Uncertainty in Margins Outlook – Although we are confident in JD’s core

e-commerce business margin upside, we understand that the company is

involved in various new initiatives, such as

Dada Express (delivery services for restaurants and other offline businesses),

cloud, and logistics, which may impede its margin enhancement trajectory. A

slower increase in its third-party

platform business may also slow down gross margin improvement. While we

believe JD management is committed to increasing its e-commerce margins,

there is intense competition in the e-commerce industry, which could

negatively impact margins.

Advertising capacity still at an early stage – Advertising only accounts for

2-3% of JD’s total business at present, according to our estimates. JD should

gradually increase its ad inventory from the current 10% level on mobile (one

out of the top 11 search results are currently sponsored ads).

Still, JD’s advertising infrastructure appears to be lagging behind its main

competitor in terms of product design and effectiveness, according to our

channel checks.

High beta of net margin – Since JD is at the edge of breaking-even (2017

adjusted net margin guidance is 0% to 1%), a small difference in margin

estimates for future years (e.g. 1% net margin estimate vs 2% net margin

estimate) would result in a big % variance in terms of EPS change, which

may lead to a significant difference when valuing the stock’s trading

multiples and thus impede its achieving its price target.

Valuations

Valuation Price Target: $44.80

0 10 20 30 40 50 60 70 80

DCF 8-10% WACC

P/E +1

P/BV +1

52 High/Low

JD.com football field (USD/share basis)

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Figure 11. WACC Buildup

Cost of equity 10.75% Risk free rate 2.35% Beta 1.20 Equity risk premium 7.0%

Cost of debt 1.5% Risk Free Yield 1.3% BBB- Corporate Rating 6.9%

Tax rate 22.0%

Market cap ( USD '000 ) 17,802,086

Total debt (USD '000) 1,015,100

WACC 10.05% Source: Bloomberg, Damodaran, NUS Investment Society Estimates Figure 12. Sensitivity Tables

Source: NUS Investment Society Estimates Figure 12. Investment Risk Matrix

Source: NUS Investment Society Estimates

DCF Model A discounted cash flow analysis was used to estimate intrinsic value of JD.Com’s share price due to concerns with its cash flow generation capabilities. The primary model is forecasted over 5 years due to the landmarking switch into profitability of JD.Com. The model is driven by online sales, segmented into key sections. On the cost front, working capital, COGS, SG&A and CapEx serve as crucial perimeters for projections due to JD’s nature as an aggressively expanding online retailer. Three cases were formulated, with the base case consisting of guidance from historical performance, annual report, industry outlook, along with investor day presentations. The DCF is most sensitive to the following factors, derivation of which are explained below. The 5 year DCF model is expanded into 10 year model in order to gauge long term cash flow generation capability of UA. Weighted Average Cost of Capital (WACC) To calculate Beta, linear regression of UA’s stock price were run against the S&P 500 for time frame of 12 months on a weekly basis and then averaged and adjusted. CAPM was used to estimate Cost of Equity, while a risk free rate and BBB- corporate bond was used during calculation of Cost of Debt in a weighted average manner. Tax shield was taken into account as UA pays income taxes for all operations. Revenue Growth Revenue growth for UA is based primarily on increasing retail sales relative to key competitors, however getting ever closer to sub 20% rates as company operations go beyond optimal scale. The quest for absolute growth in revenue is likely to result in reduced margins as JD transitions into revenue trajectory of industry leader. We estimate a 5 year CAGR of 10% slowing down to a 10 year CAGR of 6% from 2016 to 2025. Terminal Growth As the industry becomes increasingly competitive and more markets hitting saturation point, JD.Com’s growth rate will definitely slow down. This rate will reach a terminal growth rate equal to expected inflation of 0.6%, accounted for in the 10 year DCF model. Relative Valuation Using P/B, P/E, EV/EBITDA, EV/EBIT, JD.Com is significantly overpriced relative to even high growth peers as seen below in the valuation section. Using comparables as sanity checks, JD having high growth prospects is reasonably overvalued compared to peers. We factor this as one of the key investment downside. Relative Valuation was primarily focused on P/E multiple. This is due to:

1) Compact spread from 1st to 3rd quartile of peer group P/E 2) Similar trends in historical multiple movements 3) Importance of P/E as a comparable against other Sports Apparel

retailers, excluding exceptional items and goodwill amortization. This analysis leads to an intrinsic value of $44.80 for JD.Com, a 11.2 % upside to the current trading price. We remain confident that this valuation reaffirm our Buy recommendation and validates our view of upcoming 12 month period.

Investment Risks Market Risks M1: Weakening of dollar will drive foreign sales Business Risks B2: Mergers & Acquisition: By taking over a competitor in the industry, UA has the potential to reduce cut throat price competitions and improve net margins

Imp

act

Probability

Mid

High

Low

Low Mid High

B3

B2

C4

M1

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Disclaimer

This research material has been prepared by NUS Invest. NUS Invest specifically prohibits the redistribution of this material in whole or in part without the written permission of NUS Invest. The research officer(s) primarily responsible for the content of this research material, in whole or in part, certifies that their views are accurately expressed and they will not receive direct or indirect compensation in exchange for expressing specific recommendations or views in this research material. Whilst we have taken all reasonable care to ensure that the information contained in this publication is not untrue or misleading at the time of publication, we cannot guarantee its accuracy or completeness, and you should not act on it without first independently verifying its contents. Any opinion or estimate contained in this report is subject to change without notice. We have not given any consideration to and we have not made any investigation of the investment objectives, financial situation or particular needs of the recipient or any class of persons, and accordingly, no warranty whatsoever is given and no liability whatsoever is accepted for any loss arising whether directly or indirectly as a result of the recipient or any class of persons acting on such information or opinion or estimate. You may wish to seek advice from a financial adviser regarding the suitability of the securities mentioned herein, taking into consideration your investment objectives, financial situation or particular needs, before making a commitment to invest in the securities. This report is published solely for information purposes, it does not constitute an advertisement and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. No representation or warranty, either expressed or implied, is provided in relation to the accuracy, completeness or reliability of the information contained herein. The research material should not be regarded by recipients as a substitute for the exercise of their own judgement. Any opinions expressed in this research material are subject to change without notice.

© 2016 NUS Investment Society

B3: Stronger than expected overall sales growth above 20% CAGR will maintain expensive valuations Credit Risk C4: Potential raise in federal reserve rates will trigger higher interest expense in unhedged variable rate debt instruments

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Appendix:

Third Party Research Findings

Pro Forma Financial Statements

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Detailed Assumptions