Earnings Call: Q3 2019

Nov 15, 2019

Hello, and thank you for standing by for jd.com's 3rd Quarter 2019 Earnings Conference Call. At this time, all participants are in a listen only mode. After management's prepared remarks, there will be a question and answer session. Today's conference is being recorded. If you have any objections, you may disconnect at this time. I would like to turn the meeting over to your host for today's conference, Jia Zhang. Thank you, and welcome to our Q3 2019 earnings conference call. Joining me on the call today are Mr. Richard Liu, JD dotcom Group CEO Mr. Lei Xu, CEO of JD Retail Mr. Zhenghui Wang, CEO of JD Logistics Cindy Huang, CFO and Zhong Liao, our Chief Strategy Officer. For today's agenda, our CFO, Sidney Huang, will discuss highlights for the Q3 2019 followed by Richard Liu, our CEO. Other management will join the Q and A session. Before we continue, I refer you to our Safe Harbor statement in the earnings press release, which applies to this call as we will make forward looking statements. Also, this call includes discussions of certain non GAAP financial measures. Please refer to our earnings release, which contains a reconciliation of non GAAP measures to the most directly comparable GAAP measures. Finally, please note that unless otherwise stated, all figures mentioned during this conference call are in R and D. I would now like to turn the call over to our CFO, Sidney Wang. Thank you, Xia. Hello, everyone. Thank you for joining us today. We are very pleased to report another strong set of results for the Q3 2019. Our net revenue growth continued to reaccelerate, reaching 28.7%, the highest growth rate in the past 5 quarters, driven by our lower tier city allocation strategies. In particular, the growth rate for electronics and home appliance categories in lower tier cities was more than double that of Tier 1 and Tier 2 cities. And most other top 25 categories saw higher and accelerated growth rates in lower tier cities as well. Overall, over 70% of new customers in Q3 came from lower tier cities, which is a new record. And the growth rates for both purchase orders and GMV in lower tier cities reached the highest levels in the past 6 quarters. In terms of traffic, due to innovative marketing activities and better user engagement through our upgraded mobile interface, The JD mobile MAU grew 36% in September, the highest growth rate in the past 8 months, while our mobile DAU grew 35% in Q3, fastest in 5 quarters. This may surprise some people who are not familiar with China's lower tier city consumers and think they are only interested in low priced, single quality products, which have seemingly flourished on other platforms. The reality is that consumption upgrade has been quietly occurring in these regions, where average consumers may have relatively lower absolute income, but have somewhat similar or even higher disposable income than Tier 1 city residents due to significantly lower housing costs. As these consumers learned to shop online, they gradually discovered the different value propositions unique to different e commerce platforms. For jd.com, our obsession with customer experience since day 1 continues to help us win over the better half of middle class consumers even in those tier cities. It is a universal truth that middle class customers value quality assurance, everyday low prices and 1st class services, especially for high value products such as 3C and home appliances, all products where consumers pay particular attention to the quality, such as food, baby products, home furnishings, cosmetics and healthcare products. For that, we thank our competitors for not only introducing e commerce to many first time users, but also providing easy benchmarks for us to readily differentiate and secure the most valuable customer. This can be validated by our average ticket size of over RMB200 in lower tier cities, very important indicator for the quality and sustainability of our customer base. Thanks to lower tier city consumers, our market leading position in the electronics and home appliance categories has been further strengthened with the revenue growth rate accelerating to 22% in the Q3, the fastest in the past 5 quarters. Amid everlasting competition and a slowing industry, which grew in low single digits in Q3, according to China's National Bureau of Statistics. In other words, we have been taking tremendous market share during the quarter. Some of you may wonder what happened to all the subsidies that people have been raving about from our competitors. Well, this time, our archrival itself confirmed publicly that subsidies cannot bring sustainable business. This it has learned the hard way from its own costly experience over the years. 100 of millions of people may happily spend $0.99 on an impulse, and they may spend $0.99 every day on petty items just for fun. But for serious purchases, most consumers don't just look at the price alone. They will evaluate at least 2 other elements before any large purchase decisions. The first is trust. Can I trust the sellers on the platform? Are you selling authentic products? Will I get what I see or will I end up on a wait list for months before getting that discounted item? The answers are mixed at best on the overcrowded marketplace platforms. The second is service. Do you have professional installment service for large appliances? And I return it easily if I don't like the product. People may not care about the service when they buy a $0.99 peti item because they can just throw it away. But when they are buying large ticket products, they definitely care. Here comes the hard tools. It takes years of heavy lifting, build the supply chain expertise, service capabilities and fulfillment infrastructure needed, perfect the customer experience in those categories and in that process to optimize operating efficiency while solidifying our competitive moat. The best example is 3 years ago, when the largest marketplace platform listed the largest offline home appliance and electronics retailer in China to jointly attack us with massive subsidies throughout the past 3 years, but they have failed a lot miserably as we predicted 3 years ago, now widely reported in the Chinese press. So anyone still worrying about subsidies hurting our core categories should refresh their memory and think again. It's driven by the same retail fundamentals that we have reiterated all these years. There's no shortcut in this business. By the same token, our general merchandise categories enjoyed accelerated growth of 36% in Q3, led by FMCG products, another extremely difficult category for a pure marketplace operator to reach meaningful scale with or without significant subsidies. We are also pleased to see that net service revenue grew 4% year over year, the fastest in the past 4 quarters, and contributed 11.9% of our overall revenues, driven by strong momentum from 3rd party logistics and advertising revenues. External revenue has now contributed 40% to JD Logistics' total revenues on a standalone basis, up from less than 20% just 2 years ago. It has grown more than 300% from the same quarter of 2017 when we decided to expand logistics into a self sustained business, supported by its consistently top ranked customer satisfaction scores in the industry. In the 3rd quarter, our gross margin was 14.9% compared to 15.4% in the same quarter last year. This reflects the reinvestment of the first half one time gains that I mentioned on our last earnings call. Yet we have reinvested roughly 40% of the RMB 1,800,000,000 non recurring gains from the first half through the gross margin in Q3 to drive our lower tier city strategy. It works very well and you have to admit it's a much more effective strategy than a massive subsidies by some of our peers. The higher sales we achieved will give us further economies of scale in both procurement and operating efficiency, which will afford our customers even more pricing benefits, setting an even higher bar for competitive while driving our further growth and margin expansion next year. This is the beauty of our 1P business model, a self reinforcing virtuous cycle that has worked extremely well for all the number 1 third party retailers either by country or by category around the world. You have to be number 1 to enjoy this virtuous cycle and you have to have a lower cost structure than everyone else. Yi.com is number 1 in China and in multiple categories, and the snowball is beginning to roll. Another aspect of the snowball effect is operating leverage. During the Q3, our fulfillment expense ratio improved by 91 basis points, 6.5% compared to 7.4% in the same quarter last year. The improvement was driven by economies of scale as JD Logistics expanded its external order volume rapidly, benefiting both its 3P operating margin and JD's 1P fulfillment expense ratio. Our marketing, R and D and G and A expense ratios also improved meaningfully in the same quarter, driven by highly effective management and operating leverage from higher sales. As a result, non GAAP operating margin reached 2.2% in the 3rd quarter, setting a new record. JD Retail, in particular, achieved a record segment operating margin of 3.3%, and it was achieved in a quarter of heavy new investments. I hope this solid performance can begin to shed light on our path to our committed high single digit long term profit margin for the JD Retail business. Our free cash flow also increased significantly year over year during the quarter, driven by lower CapEx and the proceeds from the Phase I closing of the GIC Logistics Core Fund. In our free cash flow table, as I mentioned in recent quarters, JD Logistics, JD Property Management Group was formed to pursue financial returns as a managed business. We have broken out the related CapEx into a separate line specifying the available for sale nature, which has been reported net of related proceeds on sales. This is the 2nd time when we recorded a net cash inflow on this line following the first time in Q1 this year. We hope to see more cash inflows from this business in the future. For the trailing 12 months, our free cash flow was RMB 15 point $1,000,000,000 50% higher than our non GAAP net income in the same period, which was another bright spot in our business. Now let's discuss our 4th quarter financial outlook. We expect net revenues to grow between 21% 25% on a year over year basis in light of a highly successful singles day promotion season. While taking into account the potentially slowing national retail sales growth based on the NBS report published yesterday. On the bright side, our October growth remained resilient and we are clearly gaining market share. Finally, with better than expected earnings in the Q3, we are raising the full year non GAAP net income guidance to be between RMB9.8 billion and RMB10.5 billion. Reflecting Q4 seasonality and the continued reinvestment of the first half one time gains discussed earlier. At the midpoint of this guidance, we would grow our 2019 non GAAP net income by over 200% from the 2018 level and grow a CAGR of 43% from the 2017 level. More importantly, this robust earnings growth is on top of our ongoing reinvestment in our core business, which positions jd.com to enter 2020 with tremendous growth momentum. This concludes my prepared remarks, and I will now turn the call to Richard for a few quick remarks. Free cash flow. Thank you, Sidney. Hello, everyone. I would like to take this opportunity to give you a brief introduction on our strategy plan in 2020. And for this year, as you have seen that, we have achieved a promising result in terms of our revenues and net margin as well as cash flow. And for the next year, based on the achievement of the previous three factors, we'll continue to work on increasing our GMV and consumption of customers customer space as well as technology services. And we believe that only by improving every aspect of the four elements, we'll achieve new quality growth of the whole company. And in the past 6 years, we have been investing heavily on the investment of our technology services and this has been quite larger than the growth of our revenues. And we will and for this year, you have seen significant growth on the revenues of our technology services. Has actually achieved 3 digit growth this year. And in the future, for the next 5 years, we will continue to gain the benefit and the improvement on the revenues of our technology services, and this will be even bigger than our overall revenue growth. And we believe the technology services revenue will be the key engine for the increase of our revenues and net income, yes. We have 2 strong beliefs. And no matter it's our JD Retail, logistics and JD Digits, The technology is our key driving forces. Only through technology will bring us a long term core competitiveness. Technology will always help us to bring up our users' experience, lower the cost and improve our operating efficiency. And the second belief is that we strongly believe the income from technology services will bring even further benefits and returns and profits for our stakeholders. And overall, we believe for the next year, no matter if it's under revenues and out of profits, we will achieve even better results. Thank you, everyone. We can now move to the Q and A session. The question and answer session of this conference call will start in a moment. In order to be fair to all callers who wish to ask questions, Your first question comes from the line of Ronald Keung from Goldman Sachs. Please ask your question. Thank you. Thank you, Richard, Xu Lei, Wangzong, Sydney, Naozhong and Jia, very strong results. And further accelerating of revenue particularly for the 1P retail and profitably. So I would love to hear just your thoughts particularly as Richard talked about the 2020 strategy. Just what do we see as the positive and maybe less positive drivers just into the 2020 1P growth. I could think of a larger base. I could think of 5 gs. So anything that you see are the drivers for next year's 1P growth, particularly for electronics appliances and FMCG? My sense is mostly whether we are targeting a similar growth as last year, sort of above 20%. Any color on that would be great. Thank you, management. Of JD Retail. Let me just give you two reasons for the faster development of our YP business. First, JD is a retailing company based on the capacities of our very strong supply chain. No matter in the past, now or in the future, we will continue to improve our ability on the supply chain and working together with our partners to increase our efficiencies and lower the cost on the supply chain side to provide unique advantages to this market. And secondly, we attach great importance to users' experience. And we believe as a retailer, ensuring experience is a must. And for this year, we have done a lot of work overall across the company to ensure the enhancements of users experience. And through our NPS monitoring, we have seen the user experience has very tangible progress. We are continuing our investments on improving the user experience, not only on the new customers and also our existing customers, we are working on every front to ensure they have unique experience shopping on our platform. So in all, supply chain and our commitment to our users' experience has ensured our 1P business fast development. Thank you. Your next question comes from the line of Eddie Yoon from Bank of America. Please ask your question. Hi, good evening guys. Thank you for taking my questions. Two quick questions about the lower tier CT competition. Number 1, about the users. Just wondering, are we seeing similar users using different apps, but buying different products? Or are we seeing a more unique user segment that are coming to JD? And then secondly, how our collaboration with WeiXin and the offline retail partner network can help us in the competition in the lower tier cities? Thank you. Since our Tianqi platform, which is mainly the new channel we target to lower tier city customers, been introduced online by the end of October. It has been less than 2 weeks live online. So based on the current results, I will just share a few observations. And for the Jinxi platform, it includes 2 access points. 1 is the 1st tier access point on WeChat and another extends phone app we introduced months ago. The characteristics of the users on Jixi, of Jixi, the majority of them are coming from the lower tier cities and their shopping behavior is more social in house and have a very high conversion rate. But in terms of their ARP value and stickiness, it's relatively low compared to the main site. And in terms of the product, Jinxi platform's product is quite different from our main site. On JD's main site, the product is mainly brand products. On Jingxi platform, we are developing products based on China's strong manufacturer potential. Now we are working with over a handful of industrial belts and in the future it's going to develop into 1,000 industrial belts to identify the high quality manufacturers and help them to bring the products on the Jinsea platform in need of the customers from the local And also we realized the Genie users, their shopping preferences is rather complicated. They like to be more interactive and having more entertaining factors in their shopping behaviors. It's not rather a very simple buying habits. So by using this feature, we will work on our own progress as well as reach out multiple functions in their buying behaviors on our platform. We also want to share with the development and expansion of JD platform, we will also identify those quality products and patients who have very premier service ability to give them more presence on our main site and we believe there's a group of lower tier customers that also have the willingness and need to shop on the site in the long run. And I just want to respond a little bit more on our relationship with Tangshan. Tangshan is our shareholders and very important partners. And some of you have realized that at the end of October, WeChat has made certain rules to prevent some over promotional activities to impact the social interaction behaviors we chat. And these rules, I think, for the long term, it's a good sign because for us, we always emphasize on the user experience and this rule will help us to guarantee these aspects. So I'll just add one more point on Eddie's first question, whether users lower tier city users are buying from different apps for different categories or just stick to one app. Our survey before we got more data from Jinxie, our survey in the lower tier cities suggests that majority of the lower tier city users do use multiple apps, from basically use multiple platforms and they will pick the platform based on the categories they are buying. So that's the current observation. In the Tier 1, Tier 2 cities, you may see relatively more users stick to one app for majority of their purchases. Now with our Jing application, basically, we are creating a new brand strategy where our main app, JD app will continue to target the higher income consumers in the lower tier cities, while the Jingxi app will target the relatively low income consumers in those regions. And we can also then gain more insight on the lower tier city consumers so that we can better target them for promoting our JD main app, our core category product. That's very helpful. Thank you, guys. You're welcome. Your next question comes from the line of Xia Yap from Citigroup. Please ask your question. Hi, good evening management. Thanks for taking my questions and congratulations on the strong set of results. My question is related to your C2M initiative on the appliance brands. What are some of your differentiator on attracting the brands to partner with JD? And given the C2M model is also getting more competitive, if competitors going after the same brands, will that have any negative impact to JDE margins? And for the on related questions is that for the same appliance brands, is the C2M SKU has a higher or lower margin than the standardized SKU? If you could share also roughly the percentage of GMV coming from C2M category this quarter and how much you expect that to grow into? Thank you. Let me share with you some achievements that we have made on C2M so far. And 2 to 3 years ago, we have started our C2M model and this started in the categories of IT products and have achieved amazing success. And on this IT categories, actually, our platform, over 70% of products are streamlined to JD and this has not only impacted our platform but actually have a quite deep influence to China's And for this year, we have also made our strategic proposals to further our categories, especially on the 2 categories of home appliances and FMCG products. And compared with other online platforms, I believe there are 2 advantages to produce C2M products on JD platform. First of all, we are a company driven by technologies. We have a vast data in return to our users' comments and searching data and viewing data and combining all these data and working together with our partners will help us to generate the most tailor made products in a high manner. And secondly, per se, JD is a virtual platform and especially our 1P business. So this gives us advantage to work closely together with our brand partners together on producing those digital products. And in between, we have our capacities on the supply chain. These give us a better responsibility and capacity to produce the most effective product together with the partners and the partners will become more and more willing to work with us to reach the best. And we have realized that for different categories and industries, their purpose to produce C2M products will be different. And some of them are doing C2N products to avoid price conflicts. And by doing C2N more tailor made products will help them to reduce the conflict opportunities. And for some other brand partners, they want to go deeper into China's market to the lower cities and we know that based on our traditional supply chain, this is not an easy way. And for JD, we would like to be the company on this process with our partners to together reach new users in the lower tier cities together. That's why, based on our powerful supply chains, it will be very unique opportunity for the partner for our brand partners to work with us to be more attractive to reach our customers in the lower tier cities. And in terms of the margin, because different brands have different goals and different formats, it's very difficult to give you unified measurement. But generally speaking, the CG1 price is very competitive and there's always ways we can also make reasonable interest to benefit and profit out of that. And overall, you have already seen the success we made on the IT categories, and it has occupied a strong market share, and we believe this will be copied in other categories as well. And in the future, we'll continue our efforts on C2M and increase the proportion of products on our platform. Thank you. So just to put in layman's terms, just to give you an example on C2M margin, it's a triple win situation. So for example, for because a lot of the brands will try to protect their offline retail network, so they will monitor the sales price, which limit our ability to give more value to consumers. So for select only very large brands can do that. And then at the same time, they would also resist giving us even lower procurement price just to prevent us from selling lower price to consumers. So by C2M, we can really break through both. One is that because it's a customized product, so we wouldn't drop the brand's offline retail channels. So we can price the products lower to give consumers more benefit. 2 is that because of that same reason and we tend to buy a very large volume for these C2M products, so we can get even lower procurement price. So we can also maintain very healthy margins. And while we can also support the brands to sell a much larger volume through our powerful channel. So it's a triple win situation for the C2M model. Thank you. Your next question comes from the line of Thomas Chong from Jefferies. Please ask your question. Hi, good evening. Thanks management for taking my questions. I have a question about JD Logistics. Can management comment about the strategy in 2020? And how should we think about the top line and the margin as we go through this year? Any color would be great. Thank you. Next year, our JD Logistics strategy will continue to focus on the efficiency increase and user experience enhancement. And we'll also step up efforts on reaching the lower tier market by expanding our logistic network. And we will also work further on improving our products and our capacity to further open the external market. And we will also invest for the we'll also step up efforts on our technology deployment and the revenues from technology will continue to grow next year. And for our external orders, revenues from external orders has accounted for over 40% of the overall revenues of JD Logistics. For the next year, the ratio continues to grow. In terms of the fulfillment of the profits, we will seek further improvement in stability. Our fulfillment fee ratio has been dropped, thanks to our increasing scale. And since we are continuing to going down into the lower tier cities, it will have some short term impact on our cost. But in the long run, we believe the fulfillment fee will we are still having the space to improve. Thank you. Thank you. Your next question comes from the line of John Choi from Daiwa. Please ask your question. Good evening and thank you for taking my question and congratulations on a great set of have a question on the user growth. Obviously, as we go into on lower tier cities, we started to see a user growth acceleration. Could management give some color on what kind of user growth momentum we'll further see throughout 2020 and onwards? How much opportunity do you see if you compare yourself and your peers? And secondly, just quickly on Richard, I think you mentioned about the technology. Given that industrial Internet is one of the key themes that a lot of the other Internet companies are talking about, Can you provide us how this will change our business strategy for JD and what are the areas that we are looking into? Thank you. On the question about users growth. And as I mentioned in last quarter's call, we are targeting our efforts for the user growth on the both new customers' acquisition and old customers' maintenance. On the first half of the year, we have done a series of internal optimization optimization. And on the existing customers, we are setting up our efforts on their operations to increase their activity on our platform and their maintenance on our platform, their art value and satisfaction rate keeps going up. And also, I want to emphasize that we focus on benevolent growth of our users and we don't really want to supply user food in a fragmented and unsustainable way and we believe that eventually the quality of users will be manifested through our careful or healthy fostering process. On the maintenance of our users, what we pursued is the indicators approving all aspects, not only a mere number improvement to see many users we have acquired in a short period of time. Thank you. So, Richard was traveling, so I don't know if he has heard the question, but I can quickly share that the technology services we have in mind is more about the retail infrastructure that we have accumulated over the years. Recall we had retail as a service concept, so much of the technology know how and it's already been transformed into solutions. And we have seen demand from the industry for these solutions. So those could be clearly the starting point. There will be more in the pipeline that we will discuss more when we have products available. Your next question comes from the line of Tina Long from Credit Suisse. Please ask your question. Hi. Thank you management for taking my questions and congratulations again on the results. I have one quick follow-up on Xinyu first. So I want to know for I know that we recently launched it, but I want to know in 2020, have we earmarked like a meaningful amount of sales and marketing expense to promote it? Will that have any impact on the overall sales and marketing ratio? And my main question is actually on the GT margin. I understand that 3rd quarter GT margin was impacted because of reinvestment reinvestment of the first half one off gain. So I want to know after we reinvest all the gains for the remainder of the year, in 2020, are we going to see an uptrend of GP margin from a year on year perspective? Yes. Thank you. And as I mentioned that we will take different ways and different models to grow our market. So the GMV will not make we are seeking a comprehensive improvement on the indicators. So, we won't just pursue like one indicator growth for results. And so on the second question, generally, obviously, we haven't done our 2020 budget process, so I can't give you a definitive answer. But in general, all else being equal, gross margin should expand and for the same categories because of the economies of scale, as we mentioned in the past. So but I just wanted to also point out that the gross margin and expense line, sometimes you should look at them, particularly. I'll give you one example. And sometimes and more often than not, lower price, if used effectively, can be the best marketing spending. In other words, you can save marketing costs by promotion. And so sometimes lower gross margin could mean more marketing expense as well. Clearly, that's what happened in Q3. Our marketing expense ratio actually decreased by 0.6%, more than compensate the growth margin shortfall. So you really have to look at these gross margin and expense lines in a holistic fashion. Thank you. Just add a few things from And Xu Lei, I just want to add that since the end of last year, we have made our strategies to grow our business based on quality development and sustainability. So you have seen from all the numbers of the past three quarters this year, these are all the demonstrations of our commitment on quality growth. And in the future, we will stick to this principle to achieve quality and sustainable growth. Thank you. Your next question comes from the line of Natalie Wu from CICC. Please ask your question. Hi, good evening. Thanks for taking my question and congratulations on very solid results. Just curious, can you share something with us about the incremental margin profile from your lower tier CD orders? And also about the take rate on Jingxi, I wonder is it different versus your 3T platform? Thank you. Yes. Let me quickly answer the first question. We haven't really internally analyzed in a very detailed way. But we have the same price in lower tier city and higher tier cities and cost structure is also similar. So in general, the cost structure and the margin profile should be rather similar. But there are differences in, for example, category consumption pattern that might be different. So we but we have not analyzed this in more detail, but they should be more or less similar. So what about the fulfillment expenses? Fulfillment expenses in terms of order density, clearly, Tier 1 city will enjoy most benefit. But we have covered 99% of counties and districts, and we don't necessarily have the same fulfillment promise in the very remote areas. We do cover 90%, roughly 90% of the orders within 24 hours and they tend to be in Tier 1, Tier 2 cities and in major town areas in the most populated lower tier cities. So it's actually well designed to optimize the cost structure in the lower tier city as well. And Xuoying of City Logistics, to add on this question, it is true that different categories will have different performance in the lower tier cities. For example, for iPhone and Huawei smartphone, the growth mainly come from the lower tier cities. And for the big sized refrigerators, lower city customers like them very much because they have a larger house. And also for the luxury products, the lower tier city customers buying more and more on our platform because the traditional channels do not support their purchase needs. But all these examples now get the conclusion that the lower tier cities like the big ticket products. So we have to really analyze it under these different categories. Thank you. Understood. What about the take rate on Junxi? Right now, it's 0.6% covering the payment cost. And for the take rate in the Jinxu platform, in general, we will have a very low take rate to encourage merchants on our platform. Most of the products will have 0.6 and for some of the products will be above 1 point. We are now approaching the end of the conference call. I will now turn the call over to JD dotcom's Jiadong for closing remarks. Once again, thank you for joining us today. Please don't hesitate to contact us if you have any further questions. Thank you for your continued support and we look forward to talking with you in the coming months.