JD.com Inc. (JD, Financial) announced its financial results for the fourth quarter and full year 2023 on March 6. The quarterly results were better than expected, particularly in terms of revenue growth. Profitability declined, but this was widely anticipated. CEO Sandy Xu said, "JD's proactive actions have begun to produce results as our decisive focus on user experience, price competitiveness and platform ecosystem drives deeper and more frequent user engagement and healthier user growth momentum."
Along with the earnings release, the Chinese e-commerce company also announced a $3 billion share repurchase program and declared an annual cash dividend of 76 cents per American depository receipt. The stock surged more than 16% after the earnings release as investors cheered the earnings beat and shareholder return initiatives.
At first glance, JD's fourth-quarter results appear to be very encouraging. Upon closer inspection, however, it becomes plausible that the seemingly good quarterly results are achieved at the cost of potential erosion of its moat. In the long run, this could have significant implications for JD's competitiveness.
Earnings summary
JD's net revenue increased 3.60% from the prior-year quarter. Non-GAAP income from operations increased 6.80% year over year. Non-GAAP net income attributable to the company's ordinary shareholders grew 9.10%.
The company's income grew faster than revenue because of effective expense and cost control. For the quarter, cost of revenue increased 3.40%, while research and development expenses decreased 0.60% and general and administrative costs decreased 34.80%. However, marketing expenses rose 9.40% due to increased spending on promotional activities.
JD's heavy spending in promotional activities resulted in higher user shopping frequency and higher volume growth. Management shared more details on how the company achieved better user engagement during the earnings call:
“In Q4, we saw the number of quarterly active customers accelerate at JD Group level. This increase was particularly driven by the growth of our loyal existing users and plus members. In addition, the JD Plus growth also translated to a robust order volume growth, hitting double-digit year-on-year in Q4 and accelerating for 3 consecutive quarters. In terms of JD Plus, we saw another quarter of robust growth of its member base and GMV contributed by plus members grew faster than our total GMV in Q4. The promising progress in user engagement is a result of our stepped-up efforts in improving user experience, low price offerings and implementing platform ecosystem strategies. Looking at our efforts in improving user experience. In addition to our previously launched popular initiatives such as free shipping, instant refunds and one click for best price guaranteed, we also recently launched new customer services such as free doorstep pickup for returns, cashback for delayed shipping. As a result, our Net Promoter Score, the NPS, for both our 1P and 3P business have improved substantially in Q4.”
Peeling the onion
Once we start to peel back the layers, we can further inspect the specific actions JD's management team took to drive the user shopping frequency growth and order volume growth. We also notice the inconsistency between management's words and the financial numbers.
First of all, as management pointed out, “the number of users from lower tier markets grew faster in Q4 compared to previous quarters”. This positive development is encouraging since JD has historically demonstrated strong performance in tier-1 and tier-2 cities, but struggled to keep up with Pinduoduo (PDD, Financial) and Alibaba's (BABA, Financial) Taobao in lower-tier markets. Now, it seems JD is making progress in bridging that gap.
Second, management noted that “low ticket size orders further sped up and far exceeded the growth of JD's total order volume in Q4.” JD's management implied that growth in low ticket size is due to price competitiveness, which is not supported by subsidies, but by supply chain capabilities. This is where I noticed the inconsistency between management's words and JD's financial numbers. During the quarter, marketing expenses actually increased by 9.40%, significantly outpacing the revenue growth of 3.60%. And JD said specifically in the earnings release that the increase in marketing expense was"due to increased spending in promotion activities." So clearly the growth in low ticket size orders was driven by subsidies, at least to some extent.
Lastly, the increased number of active third-party merchants also drove user purchase frequency growth and order volume growth. Management noted that “3P users and 3P order volume both saw accelerated growth year-on-year in Q4 and in the full year of 2023.” From day one, JD's moat has been the relentless focus on authenticity and better quality. The bedrock of product authenticity and quality is first-party and JD's own logistics system. Accelerating the growth of the company's third-party business will certainly lead to a decline in product quality and an increase in user dissatisfaction. Therefore, management's pursuit of growth in third-party merchants and order volume indicate JD's management is willing to sacrifice long-term user value to drive short-term growth. This means its quarterly financial numbers, especially the revenue growth numbers, may look good in the near term. However, over the long term, its financial statements will properly reflect the potential impact of this strategic decision, which could prove to be a costly mistake.
Balanced shareholder return program
Along with the earnings release, JD announced a $3 billion share repurchase program and declared an annual cash dividend of 76 cents per ADR. As I previously stated in my analyis of Alibaba's fourth-quarter earnings:
“I think the company should think about paying more dividends to shareholders as opposed to merely increasing share buybacks because Alibaba's intrinsic value may decline in the future. If its intrinsic value does decline in the future, a cash dividend is a better option for shareholders compared to share repurchases.”
Therefore, I absolutely applaud management's efforts because JD's shareholder return program is much more balanced than Alibaba.
Conclusion
JD's quarterly revenue growth has picked up as a result of management's actions aimed at driving short-term order growth and increasing user frequency. While these actions may yield positive results in the near term, they are likely to gradually erode JD's long-term competitive advantage. Therefore, it is crucial for shareholders to consider the long-term consequences of these strategic actions.
