Bad Optics Are Creating an Opportunity in JD Stock
It has been the summer from hell for JD.com (NASDAQ:JD) and JD stock has taken a beating.
First, trade tensions started to heat up between the U.S. and China in June, the U.S. dollar soared against the Chinese yuan, and all China stocks dropped. Then, JD reported disappointing second quarter numbers alongside a weak guide, and that sent JD stock even lower. Now, news is breaking that JD’s CEO Richard Liu was arrested on rape allegations in Minneapolis last Friday.
All together, JD.com stock has dropped almost 40% from $44 in June to $27 today.
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That is a big drop. Some of it is warranted by weakening fundamentals. But, a big part of it is due to bad optics. Those bad optics should blow over relatively quickly, and this stock should subsequently bounce back.
Thus, at $27, I think it is time to buy JD stock. Fundamentals support a higher stock price, while technicals imply that the stock is way oversold in the near term.
Fundamentals Support Higher Stock Price
During JD.com stock’s almost-40% plunge over the past several months, the company’s fundamentals have weakened some but not by enough to warrant such a haircut in the stock price.
JD’s second quarter numbers weren’t great. Revenue growth is slowing. Customer growth is slowing. Margins are under pressure. It increasingly looks as if Alibaba (NYSE:BABA) will be the king of China commerce and that JD will be the second fiddle. As such, the whole narrative surrounding JD.com is getting slightly worse.
But, that narrative it still quite good. After all, revenue growth was still in excess of 30% last quarter. Customer growth was still in excess of 20%. Customers are still shopping more frequently than ever on JD.com. Gross margins are still up significantly on a multiyear basis.
The whole China commerce growth narrative remains robust, especially considering that ecommerce penetration rates are only growing, China retail sales growth remains robust, and retail in China remains highly fragmented relative to the U.S.
Overall, then, while the JD growth narrative has weakened, it remains strong. This is still a company positioned for explosive growth through capturing second place in the red-hot China e-retail market.
Meanwhile, margins are depressed right now due to big growth-related spend, but once this hyper-growth era ends, those big-growth investments will fade, and margins will come roaring back.
My bear case for JD is 18-20% revenue growth over the next five years, gross margin expansion toward 15%, and OPEX rate normalization toward 12%.
Under those assumptions, my bear case for JD is $2.50 in earnings per share in five years. A market-average 16X forward multiple on that implies a four-year forward price target of $40. Discounted back by 10% per year, that equates to a year-end price target of $30.
Thus, even in a realistic bear-case scenario, I think the fundamentals support a year-end price target for JD stock of at least $30.
Technicals Point to Oversold
On the technical side of things, JD has plunged into deeply oversold territory.
The stock’s relative strength index (RSI) has fallen into oversold territory (below 30) and is at its lowest level in five years. Normally, whenever JD stock’s RSI dropped below 30, it bottomed and proceeded to rebound over the next several weeks to months.
Meanwhile, the stock is now trading more than 25% below its 200-day moving average. That is a steep discount. Indeed, it is the farthest below the 200-day that JD has traded over the past five years. During that stretch, JD normally has bottomed when the stock price dipped 20% below the 200-day. Thus, at a 25% discount, it is fair to say that we are near a bottom.
Bottom Line on JD Stock
The optics surrounding JD stock are awful right now. But, as optics always do, they will eventually blow over, and investors will pay attention to the fundamentals. Those fundamentals support a price tag of at least $30 by the end of the year, if not higher. As such, I’m a buyer on this dip and expect healthy upside in both the near and long term.
As of this writing, Luke Lango was long JD and BABA.
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