VIPSHOP HOLDINGS LTD -ADR VIPS
April 10, 2018 - 5:11pm EST by
Shoe
2018 2019
Price: 17.00 EPS 1 1.4
Shares Out. (in M): 574 P/E 17 12.1
Market Cap (in $M): 11,170 P/FCF 24 15.7
Net Debt (in $M): -904 EBIT 679 1,082
TEV ($): 10,266 TEV/EBIT 15.1 9.5

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Description

Summary - Buy VIPS

- Buy VIPS - Vipshop stock at $17.  The converts are also interesting

- The stock has ~100% upside and ~24% downside

- VIPS is the 3rd largest e-commerce company in China focused on apparel and flash sales

-  There are plenty of reasons to own this as they outline and execute the story and the recent JD/Tencent partnership & investment (announced in December) benefits are seen over the next 4+ quarters.  Tencent and JD invested $863mm into VIPS at a $13/share (stock now at $15.3) and have a 12.5% stake

   - To put this into perspective, imagine as if FB and AMZN invested in MercadoLibre and wanted to help MELI get more & cheap web traffic and help MELI with logistics and shipping.   That's pretty much what's happening with VIPS being helped by Tencent and JD in apparel right now.

  - Basically, VIPS will benefit greatly from a step function increase in web traffic and lower user acquisition costs.  And on the cost side, they'll have much lower traffic acquisition costs (maybe 30-40% lower), better sourcing, and could rely on JD's logistics platform

   - I think the partnership could boost rev growth (by at least few hundred bps, while consensus actually has rev growth decelerating) and user growth (millions and millions more) over the next few years and help margins as well (they're probably sandbagging the margin benefits for now)

- I think people will want to own this and hold this over the next year given the positives and catalysts on the horizon.  Plenty of reasons to own it, few reasons to sell. I also think both the numbers and the multiple have plenty of room to rise as well

 

- Although the financial and operating impact of the partnership will start more meaningfully in Q2 or 2H 2018,  I think the stock will be buoyed by the potential benefits in the near term

  - It's hard to quantify the exact benefit,  but safe to say that the positives could be huge  for VIPS.

    - when Tencent invested and partnered with JD, JD's GMV accelerated by 30-40% and they got 28mm new active customers.  VIPS has 58mm active customers now and could also see 25-35mm new customers. Zulilly had a similarly big boost when QVC bought it and drove traffic to the site

- the spin-off of VIPS’ finance division is also a positive catalyst that should come later this year.  Of course internet investors don’t like to see companies becoming financial companies and lending to customers and retailers to drive sales

 

- it’s also rare in Internet-land to find companies with flat or expanding margins.  VIPS is one of those rare companies. For now, they’ve guided to flat net income margins at 3.5% as they reinvest the savings to grow the topline and user count faster.  But I think they’re sandbagging the customer acquisition cost savings and potential logistics/sourcing/warehousing savings. Given JD has the #1 logistics system in China (better than BABA), it makes sense that VIPS could piggy back off JD and slow their own logistics investments

 

- From a macroeconomic perspective, China’s GDP per capita is only at ~$8,500, and has doubled over the last 8 years. This compares to the United States’ GDP per capita of ~$60,000 – clearly, China’s consumer spending power has much room to grow, which is a continued tailwind for VIPS and all Chinese e-commerce companies. The Chinese government is also on a mission to fuel consumerism and switch to a domestic led economy and away from an export driven economy, which is another macro tailwind.

 

Valuation - VIPS stock

- at $17, it trades at 24x LTM EPS of $0.74 and 22x 2018 P/E on consensus numbers of $0.85, which only bake in limited benefit from JD and Tencent in 2018 and it ramping up in 2019

- I think consensus expectations are pretty low, and the multiple is only slightly elevated for what is a rapidly growing Chinese Internet company (that is growing revs in the 20%-30%+ range going forward

- VIPS is also attractive from an asset standpoint with 58mm customers (as of Q4 2017) and a very broad logistics / e-commerce platform.  They're the #3 e-commerce platform in China with a solid logistics network as well.

 

Upside

- I think VIPS' earnings could ramp up dramatically as they see a lot more cheap traffic, lower TAC, and lower shipping costs/expenses/marketing.  They could do $1.40 in EPS in 2019 (first full year of the JD and Tencent partnership), and the stock could trade at 25x P/E (not an unreasonable multiple for a company growing revs and EPS in the high 20s), for a $35 stock,  up from $17 now, or up 100%+

 

Downside

- In a downside case, the stock could trade down to where Tencent and JD recently invested,  or $13, which is down 24%

  - $13 would only be 14.5x $0.90 in 2019 EPS (which is my conservative case), which seems pretty achievable for them given the benefits that they'll get  

   - they did $0.72 EPS in 2017.   $0.90 is only 12% annual growth

 

Risks

- BABA goes after VIPS and doesn't let apparel companies sell on VIPS like they did with JD.  BABA forced apparel companies to chose between BABA and JD. I think that's unlikely since then BABA would definitely be accused of being a monopoly.   VIPS was asked about this risk on the call, but they deflected, saying that suppliers would welcome another outlet

  - Retailers have already been returning to JD.  I think BABA’s realized they were being too heavy handed and setting a bad precedent.  So that risk is off the table

- Maybe this turnaround doesn't work:  Unlikely, and at least in the short term VIPS will benefit a lot.  VIPS and JD have little overlap in customers. VIPS skews more rural and female and apparel.  JD skews more urban, male, and non-apparel. So it’s a nice fit. Tencent is an amazing traffic generation engine.  

 

Capital structure

- There's only one bond in the capital structure $629mm issue and there's a lot of cash.   

  - Cash at year end post the Tencent/JD investment, is 8.5bn RMB.  There's only 4.87bn RMB debt (a convert)

  - so it's 0.9x gross leverage and at a net cash position of $904mm.  So the convert is rock solid from a credit perspective. Very clean balance sheet

  - VIPS trades in the US and has a $11.1bn market cap.  Very liquid stock.

- VIPS is a US listed Chinese internet company.  

 

Convert Details:  they also have a pretty interesting convert if you’re into it

- It's a regular convertible bond with a $20.12 conversion price and a stock price of ~$17, 1.5% coupon a 1 year till maturity .   So it's still out of the money. Hence why it's trading at 108.

- It's a $629mm issue size and is pretty liquid (issued in USD)

- there's plenty of positive convexity in the bond (downside is par, -7%) and 60% upside

 

Business Overview:

- Vipshop is a Chinese apparel focused e-commerce site (although they’ve been selling other female oriented products, e.g. beauty), and is basically the TJMaxx / Ross Stores of China (except all online) focused on clearance.  They also do flash sales

 

History / Timeline:

- From 2012-2015, the company did extremely well, and the stock went from <$1 to $30

 - the company was growing rapidly (revs and EPS growing 100%+ at times) and had a niche in online flash sales and off-season clothing.  

   - VIPS had multiples as high as 40-50x P/E

- in early 2015, the company's rev growth started decelerating and margins were under pressure.  Competition from BABA and JD were partly to blame. Also people worried that it'd be harder for VIPS to attract new customers, as customer-acquisition-costs rose and BABA & JD were getting more competitive.  Also there was concern that it’d be harder to find good, off-priced, apparel and other items as we got further away from the Great Recession

  - however VIPS was actually still growing revs in the 20%-40% YoY, but margins were shrinking as VIPS grew at all costs, and started doing some sketchy customer financing

- the stock recently bottomed at $8 in Q4 2017,  or ~11x P/E. Quite cheap, but it seemed like no multiple was too low for them even though they still have a lot of users, revenues, top line growth, and a well known platform.  EPS growth started to stall as well from 2015-2017

 

JD and Tencent Partnership

- Then, in December 2017, Tencent and JD (the leading Chinese internet companies) invested in Vipshop, buying 7% and 3% stakes in Vipshop (respectively) at a 55% premium or $13.08 / share.  

   - Tencent and JD are now cooperating with VIPS

   - for JD and VIPS, this was a competitive response against BABA after BABA locked up apparel companies by forcing apparel companies to choose between being exclusive to Alibaba, or be kicked off the platform otherwise.  Of course, almost all apparel companies went with BABA and dropped JD at the time, but are now returning

 - For Tencent, they've been making partnerships and investments in retail, e-commerce, and brick & mortar.  They're mostly just planning on being a driver traffic and getting a cut in return. Tencent is basically the FB of China

     - Tencent has been doing this across many industries and across retail.  They've been establishing JVs or making investments, and then helping their partners get cheap web traffic.  Tencent then shares in the growth. This has been Tencent's way of competing with BABA and building Tencent’s own empire.  Tencent is helping and working with BABA's enemies.

I think this is a big win-win-win for Tencent, JD, and VIPS

- Tencent gets to share in the profits with its JV partners.  And it helps them get into e-commerce (a large growing area)

- JD gets a partner to sell apparel.  BABA recently shut JD out of selling Apparel recently by forcing apparel merchants to chose between BABA and JD.  So instead, JD will also push traffic and work with VIPS to sell more apparel instead

- Two of the main concerns around VIPS were lack of good product (since they are 70% off season), and difficulty in attracting and retaining customers given the competition.  This new tie up solves both those issues: they'll get cheap traffic from Tencent and JD, and get more inventory and support from JD. JD is has a better logistics platform than BABA

   - in China and in other parts of the world, similar partnerships have worked really well

  - they haven't disclosed the exact numbers around the Wechat partnership,  but VIPS has said that they'll get a lower/discounted CPC. Plus they'll have better targeting with Tencent's data.

Traffic acquisition cost from JD is likely to be 30-40% lower (according to sell side reports).  

- as of Q4 2017 earnings, VIPS has said that their new customer acquisition costs will definitely go down and margins will improve, and they'll be able to add many new customers from both JD and VIPS.  However, VIPS will reinvest those savings, leaving net margins stable (3.5%) as they focus on growing customers & revs, and enable more operating leverage in the long run.

- JD will also assist Vipshop in hitting GMV targets through the JD.com platform

- There are also many logistics/shipping/sourcing synergies from JD that they should benefit from,  but they haven't talked that up at all. I think they have plenty of margin expansion opportunities longer term

 

March / April 2018

- JD and Tencent have established links to VIPS now

 

Q2 / 2H 2018 / 2019    JD/Tencent/VIPS partnership ramps up

- they'll start pushing web traffic to VIPS in Q2 or 2H 2018.  

  - Tencent and JD will give VIPS some prominent real estate on their apps and websites.  They will also try to hit certain GMV targets

 - VIPS will have to also learn how to better monetize and capture this new traffic

- So you could see revs, margins, and growth really inflect starting in Q2 2018 and beyond as they get cheap web traffic from Tencent (lower traffic acquisition costs), and utilize JD's leading logistics infrastructure (which is actually better than BABA's right now)

 - the overlap between JD and VIPS users is low.  JD also could benefit from VIPS female skewing user base

- VIPS also has a underutilized, large logistics network, which they could cut back on and rely on JD's instead

 

Charts:

 

VIPS stock 1 year

- The recent spike up and rally was right after Tencent and JD made an investment


VIPS stock 5 year

- the early run was when VIPS had a lock on the flash sale, discount apparel market in China

- then BABA and JD started competing, rev growth feel and margins contracted

- however VIPS continued to grow users and revs the whole time pretty rapidly (in the teens / 20%+)

VIPS P/E history

When VIPS was doing well, it got as high as a 50x P/E multiple

But over the last 3 years people started worrying that they'd lose share to Alibaba and JD, and couldn't acquire new users profitably (since BABA and JD are already so dominant)

However, even despite trading year a 10x P/E multiple,  they've been growing revs in the 20%s still

 





 

Q4 2017 earnings review

Vipshop's Q4 call was upbeat and positive

- will start to see Tencent ramp up in Q2 and through the year.  Already trialing it in Q1

- JD ramp up starts in Q2 and ramps up

- Q1 guidance sounds conservative

- they expects to reinvest the savings to drive topline growth.  Expects savings across customer acquisition / traffic costs, bargaining power with suppliers, and logistics

- moving into new categories (furniture and international/luxury brands)

- expects less investment in customer finance and logistics in 2018

- the spin of the financing arm is delayed, but will happen

VIPS +6% to 17.38.  China internet up 2.6% also

 

Details:

Tencent & JD partnership - of course, most the call was around the partnership and strategic investment with Tencent

- VIPS will get better traffic, leveraging Tencent's social ecosystem and big data capability.  customer acquisition costs will definitely go down and customer acquisition will be easier

- also increases bargaining power with suppliers

- has many other ways to collaborate

- already opened a trial entry on WeChat Wall in Feb to 5% of users (already known) and on track to open the entry on JD's app in late March.  So will see some contribution in Q2, and ramp up in Q3 and Q4. This will mostly help on user growth, but probably not ARPU

 - will take a quarter for top line and customer growth to ramp up and take time for users to discover and try the new channels

- plans to grow their top line as fast as possible while maintaining a stable income margin to strengthen their leadership in core categories and fashion,  and enable operating leverage in the long run. But in near term, reinvesting the benefits from lower acquisition costs or higher operating leverage

- will need to pay a commission to JD and Tencent but they aren't disclosing it

- will continue to do flash sales, but will adjust some features for JD and Tencent customers

- expects the customers from Tencent and JD will be new

 

Logistics

- continues to expand their warehousing capacity and logistics.  They added 1 warehouse and have 15 now

- expects there is room for both VIPS and JD logistics in the large China logistics market.  But they are discussing ways of collaborating warehousing and transport to lower their costs

 

Customer Finance segment - spin delayed by on track

- the spin is pushed back due to the deal with Tencent and JD

- 5mm customers use their financing, up 107% YoY.  4.7bn RMB credit outstanding to customers, and 1.5bn RMB to suppliers

 

Categories

- moving into furniture

- adding more luxury items and international brands, but it's small for now

 

Q4

- revs +27% YoY < a bit of acceleration

 - had promotional events did well

- ARPU +22% YoY, +22% average number of orders per customer

- margins down YoY (but inline) due to promotional activities

- they already had a lot of logistics spending in 1H, which came down 2H

 

2018

- they invested a lot in their logistics platform and finance in 2017 which hurt margins.  Expects the dag to be a lot smaller in 2018

 

Q1 2018

- rev guidance of +20-25% YoY is reasonable (they did 27% in Q4)

 

Convenience stores

- they opened 6 stores and are testing them out with their logistics platform.  Could be dual store / delivery points

 

------

Q4 2017 Earnings

 

Solid beat from Vipshop (online apparel retailer in China).  Big Q4 beat and Q1 guidance also better than expected, which was surprising given that the partnership didn’t ink yet

 

VIPS is up +10.25% in after hours to 18.07, was up 6.8% during the day

 

VIPS recently got a strategic investment from Tencent and JD, who will be sending a lot of high quality traffic towards VIPS starting in Q2/Q3.  They could also help with VIPS' e-comm logistics, and reduce VIPS' traffic/customer acquisition costs, which should be a big boost to revs and margins.   So VIPS had a decent quarter even without Tencent + JD's help yet

 

Reports Q4: solid beat

- Revenue $3.71B above FactSet $3.55B  +27% YoY (similar to full year growth of 29% YoY) < driven by improved customer loyalty and stickiness,  Orders +22% YoY

- EPADS $0.22 above FactSet $0.19  -11% YoY

- Total orders for Q4 of 2017 increased by 27% year over year to 104.2M from 82.0M in the prior year period.

- The number of active customers for the full year of 2017 increased by 11% year over year to 57.8M from 52.1M in the prior year.

- operating margin 4.7%, down 150bps YoY

- gross margin 21.7%, inline down 180bps YoY

 - margins have been weak for a while since it was hard for them to compete against BABA and JD

 

Q1 Guide - good

- net revenue CNY19.1B and CNY19.9B,   above CNY 19.15B cons. representing a year-over-year growth rate of approximately 20% to 25% vs FactSet 20%

 

Tencent + JD commentary - not much new

- "we announced our strategic partnership with Tencent and JD.com, which we believe will contribute meaningfully to our customer growth and market share gain.

- We believe the high-quality traffic from Tencent and JD.com will boost our topline growth, enabling us to achieve further operating leverage in the long run."

"In the fourth quarter of 2017, Vipshop received strategic investment of approximately US$863 million from Tencent and JD.com in consideration for newly issued Class A ordinary shares of Vipshop (the "Investment Shares") representing approximately 10% of Vipshop's total issued shares. As a result, Tencent and JD.com beneficially own, taking into account any existing holding, approximately 7% and 5.5%, respectively, of Vipshop's total issued shares. The Investment Shares are subject to a two-year lock-up period, and Tencent and JD.com have the right to appoint a director and an observer, respectively, to Vipshop's board of directors. In order to maintain director and board observer rights after the lock-up period, Tencent and JD.com have to increase their holdings of Vipshop's total shares issued to 12% and 8%, respectively, unless otherwise agreed to by Vipshop. Concurrently with the strategic investment, Tencent, JD.com and Vipshop established strategic partnerships, through which Vipshop will have traffic access on WeChat Wallet, JD.com's main page, and JD.com's WeChat Discovery shopping portal."



I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

- Tencent and JD roll out more partnerships and linkages with VIPS over the next year or so

- JD and VIPS detail cost synergies

- VIPS financial metrics accelerate

- China e-commerce continues to grow 

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