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JD.com Stock’s Problems Go Beyond the U.S.-China Trade War

Vince Martin

It’s tempting to believe that JD.com (NASDAQ:JD) is an attractive stock held down only by trade war worries. After all, JD stock, even with a strong 2019, sits about one-third below 2018 highs. And it looks reasonably cheap from a fundamental standpoint, with a 26 times forward multiple despite analyst expectations for 250% growth in earnings per share between 2018 and 2020.

JD Stock Is in a Holding Pattern for Now, but It Won't Last Forever

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To be sure, I do believe JD stock is somewhat undervalued. I wrote last month after the company’s blowout earnings report that the stock should keep rising. JD.com shares have moved higher, though resistance at $32 continues to hold.

And JD stock clearly has taken some hits from trade war sentiment. Most notably, the stock fell 19% in eight sessions starting in late July, during which time the U.S. announced new tariffs on China. The distance from 2018 highs, too, might seem trade-related.

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But the story isn’t quite that simple. That doesn’t mean JD.com stock is a sell. Again, I see upside from current levels. But it does mean that a trade war resolution, if and when it comes, might not be the catalyst some bulls hope.

The Currency Effect on Chinese Stocks

There no doubt is some trade war impact priced into Chinese equities at the moment. For instance, the iShares MSCI China ETF (NASDAQ:MCHI) still is down 23% from January 2018 highs.

But one notable contributor to that decline has been currency. The Chinese yuan has fallen over 10% against the dollar over that span. That means profits — and expected profits — are less valuable in American dollars. And given that Chinese companies, including JD.com, generate nearly all of their revenues domestically, currency alone likely has driven roughly half the decline in Chinese stocks over the past 20 months.

JD Stock Underperforms

Meanwhile, JD stock — perhaps surprisingly — actually has underperformed that ETF over the same period. JD shares have dropped almost 40%. And there have been some company-specific factors driving the decline. 2018 results were disappointing. JD missed Street estimates for revenue in both the second and third quarters. For the year, non-GAAP net income declined 31% in local currency.

To be sure, JD was investing in its business, which created some pressure on margins. And the huge second quarter — in which margins rebounded — suggests those investments are paying off.

Still, this year, revenue growth has slowed, to under 17% year-over-year in the first half. That’s notably slower than larger rival Alibaba (NYSE:BABA). Pinduoduo (NASDAQ:PDD) grew its revenue 169% in the second quarter, albeit off a much smaller base.

Again, none of this is to suggest that JD stock is a short or a sell here. At 26x forward earnings, valuation is reasonable in the context of current growth. But there are risks here. A number of key employees have left of late. Margins are exceedingly thin. Any incremental pricing pressure can lead to a repeat of 2018’s earnings decline.

And some of these issues have been a factor in the underperformance of JD.com stock. This isn’t just a trade war problem.

Is JD.com the Right Play?

Would a trade war resolution help JD stock? Absolutely. But there’s certainly a risk that it could be what is known as a “sell the news” event. It’s not as if investors have simply dumped the sector: MCHI has gained almost 12% this year and JD.com stock has risen 43%. Some kind of resolution — at some point — already is priced in.

There’s another question as well: Is JD stock necessarily the biggest beneficiary of a trade war resolution? I still think there’s an intriguing long-term case for iQiyi (NASDAQ:IQ) despite disappointing earnings. NetEase (NASDAQ:NTES) and Tencent (OTCMKTS:TCEHY) could be interesting as well.

Forced to choose, I’d still pick JD. But that choice would be made understanding the risks. Margins are thin, competition is intense and China has economic issues that go beyond tariffs. Those factors will hold with or without a trade war — and they suggest that JD isn’t simply going to soar once a trade accord is reached.

As of this writing, Vince Martin has no positions in any securities mentioned.

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