Another interesting article about China's E-commerce movement today.
E-commerce leaders partnering with retailers. In August, JD.com invested USD700m for a 10% stake in Yonghui Superstores (not listed), a supermarket chain. Days later, Alibaba surprised the market by investing USD4.6bn in Suning (002024 CH, not rated), one of China’s largest consumer electronics chains. In our view, both of these deals highlight the value that physical assets can bring to online retail by extending product offerings and improving customer service. We note that Baidu has not partnered with an offline retailer, instead focusing on improving its value as a gateway for all local service providers. In terms of physical assets, Baidu has taken a stake in Uber (not listed), which could play a role in last-mile delivery.
Partnerships likely to continue. We expect Alibaba will continue to partner with offline players to develop China’s on-demand economy. Executive Chairman Jack Ma has said that investing in Suning will create a new commerce model that fully integrates online and offline (Alibaba’s press release, 10 August 2015). Alibaba has high aspirations for Ali Health and recently launched its O2O initiative, Koubei (not listed), partnering with Ant Financial (not listed). JD.com aims to gain wallet share by developing JD Home, serving customers’ daily shopping needs such as fresh food. Baidu has partners to strengthen its platform assets which include mobile search, map, Nuomi, Takeout Delivery and Baidu Wallet.
Preferred ways to invest in this theme. In the Internet sector, JD is the most highly geared towards this theme as its fast and reliable delivery capabilities are already a key selling proposition and adding fresh products and strengthening its delivery (especially in the cold chain required for fresh food) should bolster its consumer appeal even further. For retailers, such as Sun Art and Gome, we see potential cooperation with Internet companies as a re-rating catalyst. By leveraging on their procurement, product selection and logistical capabilities, Internet companies can extend their online offerings offline and retailers can benefit from more customers and sales.
Our preferred stocks in the space are Alibaba (BABA US, Buy, TP USD111), JD.com (JD US, Buy, TP USD38), Baidu (BIDU US, Buy, TP USD230), Sun Art (6808 HK, Buy, TP HKD8.9) and Gome (493 HK, Buy, TP HKD1.52).
Alibaba (Buy, TP USD111): Our thesis rests on three points. First, we believe Alibaba is best positioned to benefit from rising rural consumption given its eco-system and asset-light model. Second, it is meeting the needs of urban consumers by offering a wide selection of international merchandise direct from global merchants in China. Third, we see option value in its stake in Ant Financial. At the current price, Alibaba trades at a 22x March 2017 price-to-earnings, which we find attractive given our estimated earnings per share compound annual growth rate (EPS CAGR)of 40% from March 2016 to March 2018. We use a sum-of-the-parts to value Alibaba, including a discounted cash flow (DCF) for the core business (USD96), its stake in Ant Financial (USD7) and its investment portfolio at book value (USD4). Downside risks include worse-than-expected mobile monetization or lower margins.
JD.com (Buy, TP USD38): Our Buy thesis rests on three points. First, JD.com is highly levered to benefit from the changing tastes of urban consumers in China. Second, the company’s substantial investment in warehouses, logistics and last mile delivery pose high barriers to entry to most competitors and should provide economies of scale. Third, the shares are down 30% from its peak in June on concerns over a slowing Chinese economy. We use value JD.com, including a DCF for the core business (USD34), its warehouse and logistic business (USD3) and its investments at book value (USD1). Downside risks include macro weakness, competition from both online and offline players, margin pressures and execution risks.
Baidu (Buy, TP USD230): Our thesis rests on three points. First, we believe Baidu is well positioned to win in O2O by leveraging its mobile gateways, sales force and technology. Second, its core search business is a natural monopoly with long-term growth and 50% operating margins sustainable for the next several years. Third, we believe the valuation is attractive, trading at 24x our 2016e EPS. Our TP is derived by applying a 0.9 PEG on our 2016e EPS and a 2016-19e EPS CAGR of 32%. Downside risks include a slowdown in the core search business and competition in O2O and video.
Sun Art (Buy, TP HKD8.9): Our Buy rating on Sun Art is a non-consensus call. We believe it is a longer-term beneficiary of industry consolidation in the physical grocery retail channel. By adopting effective e-strategies, we believe it is well positioned to make the transition to an omni-channel retailer based on: 1) its unique positioning as the only national online food specialist; 2) its procurement expertise and market-leading procurement scale; 3) its online strategy leveraging its existing logistics infrastructure, enabling it to expand faster; and 4) strong execution record in new business ventures. Our DCF-based TP implies 26x 2016e EPS and 0.66x 2016e sales. Downside risks: lower-than-expected inflation; slower-than-expected same-store sales growth (SSSG); greater-than-expected losses from e-commerce. Catalysts: pick-up in inflation; online to offline (O2O) by tie-up with internet companies.
Gome (Buy, TP HKD1.52). Its successful transition to the omni-retail model from a pure offline retail model ensures that it has been able to achieve market share gain at no cost to margins.
The announced plan to acquire the unlisted store assets from its largest shareholder, Mr Wong Guangyu, at total current consideration is HKD9,095m is accretive to existing shareholders. If the deal goes through, the prospects for the company should improve, as: 1) it would give Gome exposure to fast growing areas in central and west China that are not currently covered by the listco; 2) GPM could increase: 51% stores to be acquired are located in tier-2 cities, where competition is less than in higher-tier cities; thus the GPM at physical stores is 1.5-2% higher than that under the listco; 3) the omni-channel strategies should accelerate: the total number of stores would go to 1,803 from 1,213 and the group could fully integrate the logistics and warehousing, after services, online sales and procurement. The deal is subject to shareholders’ approval in mid-November. Our DCF-based TP implies a 15x 2015e PE, in line with its historical average PE since 2010. Downside risks: listco loses management and services fees of RMB112.5m after tax.
http://www.barrons.com/articles/china-internet-stocks-why-clicks-are-buying-bricks-1447919795
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