China’s e-commerce companies: The challenges ahead

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Having announced their 3Q21 earnings, both Alibaba and Pinduoduo saw their stock prices plummet. Upon thorough analysis of their quarterly reports and of JD.com’s, as well as their senior management’s earnings calls for analysts, we would like to share with you the latest development of China’s e-commerce industry.

As the Chinese government bolstered enforcement of its antitrust law, precipitating an upheaval that reverberated across the domestic e-commerce industry, multiple companies moved to ride on the opportunity to broaden their business into each other’s territory: Alibaba ramped up investments in Juhuasuan and Taote, while JD.com launched the new app Jingxi, with the objective to compete with Pinduoduo.

Pinduoduo, being part of the Tencent camp, used to have its competitive advantage sheltered by the tech giant, who restricted Alibaba to operate within its ecosystem before the antitrust crackdown, making it difficult for Alibaba to promote its products on WeChat. But with the anti-monopoly regulations coming into effect, Pinduoduo practically lost its unique position on the WeChat platform.

While Pinduoduo has grown rapidly over the past few years, where it surpassed Taobao in monthly active users, the e-commerce platform is nowhere as profitable as Alibaba. Whether Alibaba can take advantage of the antitrust law to overtake Pinduoduo is still yet to be seen, but the battle for the e-commerce space is set to intensify.

In addition to moves against Pinduoduo, Alibaba and JD.com have also stepped up their investments in live broadcasting. Short video platform newcomers, such as Kuaishou and Tiktok, have achieved tremendous success over the past two years. In addition to advertising revenue, the growth potential in live commerce cannot be ignored.

Short video platforms generally command a degree of stickiness among users that is comparable with that of WeChat. So if business models such as live commerce prove to be successful, it will also brighten the growth prospects for Alibaba and JD.com – no doubt live commerce will become a heated battlefield for market players. Having said that, the Chinese government has announced plans to tighten scrutiny over live commerce, so it is difficult for now to predict where the industry is headed.

This, however, is also an obstacle many investors in the internet industry encounter. Given that both competition and regulations have intensified, it leaves little visibility for investors over just how profitable the industry will be. But what is confirmed at present is that the costs of running e-commerce platforms have indeed gone up.

Rising cost concerns

While Alibaba is a highly diversified conglomerate – encompassing cloud computing, media, and entertainment businesses – all of these arms except for its e-commerce platform are still making a loss.

The cost of Alibaba’s e-commerce business soared significantly since the beginning of 2021, which the company attributed mainly to investments in new growth areas, including Juhuasuan, Taocaicai, AliExpress, the Southeast Asian arm Lazada, transportation business Cainiao, and subsidies for merchant users.

New expenditures like these reduced the EBITA Margin of its e-commerce business from 31% to 19% in 3Q21[1]. But it is not clear how much of it was allocated to support business growth and to actual subsidies for small- and micro-enterprises, given that the company did not elaborate on what merchant subsidies entailed.

As for Pinduoduo, marketing and sales costs have always made up the bulk of its operating costs, which at its peak stood above the company’s sales revenue. In Pinduoduo’s earnings call, the company indicated plans to reduce marketing and sales expenses, and will step up investments in technology research.

Strong marketing and sales expenses were believed to contribute sizeably to Pinduoduo’s expansion, so when its 3Q21 sales growth missed market expectations, it sowed seeds of concerns among investors that the drop in such expenses had started to hit Pinduoduo. 4Q usually is the strongest quarter of the year, we think investors should stay put and see how the company performs in the last quarter of 2021.

The board of Pinduoduo has also just given the green light to allocate RMB10 billion to the development of agricultural science and technology in China, and made clear that it is not a commercial decision. If Pinduoduo makes approximately RMB2 billion in each coming quarter, which we extrapolated from its average quarterly net profit in 2Q and 3Q of 2021, we estimate that it will likely only break even over the next three to five quarters[2].

JD.com’s business can be divided into retail, logistics and transportation, and newly added businesses, with the retail segment making the biggest contribution to its pool of profits. The other two arms were, however, still in the red[3]. While the retail division’s 3Q21 non-GAAP operating profit margin was relatively stable compared with the same period 2020, investors have to be aware that its increased equity incentive expenses under such accounting standards also led JD.com’s operating profit margin in 3Q21 to fall quarter-on-quarter to 1.2% from 2.5%3.

[1] Source: Alibaba Group, as of Nov 2021

[2] Source: Pinduoduo, as of Nov 2021

[3] Source: JD.com, as of Nov 2021

Disclaimer

This document is based on management forecasts and reflects prevailing conditions and our views as of this date, all of which are accordingly subject to change. In preparing this document, we have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public sources. All opinions or estimates contained in this document are entirely Zeal Asset Management Limited’s judgment as of the date of this document and are subject to change without notice.

Investments involve risks. Past performance is not indicative of future performance. You may lose part or all of your investment. You should not make an investment decision solely based on this information. Each Fund may have different underlying investments and be exposed to a number of different risk, prior to investing, please read the offering documents of the respective funds for details, including risk factors. If you have any queries, please contact your financial advisor and seek professional advice. This material is issued by Zeal Asset Management Limited and has not been reviewed by the Securities and Futures Commission in Hong Kong.

There can be no assurance that any estimates of future performance of any industry, security or security class discussed in this presentation can be achieved. The portfolio may or may not have current investments in the industry, security or security class discussed. Any reference or inference to a specific industry or company listed herein does not constitute a recommendation to buy, sell, or hold securities of such industry or company. Please be advised that any estimates of future performance of any industry, security or security class discussed are subject to change at any time and are current as of the date of this presentation only. Targets are objectives only and should not be construed as providing any assurance or guarantee as to the results that may be realized in the future from investments in any industry, asset or asset class described herein.

What are central banks signaling?

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Not only are stock-picking skills a key component to how competent an investor is, being cognizant of global political and economic developments, with monetary policy trends among the most important elements, is another.

But perplexed by whether the surging inflation levels are structural or transitory; and, if it is indeed structural, will central banks extend a greater degree of tolerance towards persistent inflation, or will their determination to tighten policies and stabilize price rises at 2% trump everything else, the current market is all but certain about where future monetary policies are headed.

Recent economic data and the Federal Open Market Committee’s (FOMC) meeting minutes can perhaps shed some light on the questions above.

Among major economies globally, the US has shown the strongest economic growth thanks to its aggressive fiscal and monetary policies, with its GDP figures surpassing pre-pandemic levels[1]. Compared with the US, both the EU and UK have seen a more moderate pace in economic growth, with Japan largely lagging behind1. But China, even though it is least affected by the pandemic, could be confronted with headwinds including the recent clampdown on the property market, a potential slowdown in export growth, and businesses being slow to adapt to antitrust laws, among other risks.

Moreover, divergence in growth trajectories could also influence the direction of future monetary policies. The FOMC meeting minutes released in early November indicated that debt purchases in its quantitative easing program will be gradually drawn down starting December. In November, the Fed bought US$70 billion in Treasury bonds and US$35 billion in mortgage-backed securities each month, which will be scaled back by US$10 billion and US$5 billion per month respectively[2]. At this rate, the Fed will be wrapping up its bond-buying program by the end of June next year. But when will it begin raising interest rates? Richard Clarida, Deputy Director of the Federal Reserve, believes that the end of next year could be an optimal time to start doing so[3].

And the Bank of England, which has largely concluded its bond-purchasing program, is looking to raise the target interest rate from the current 0.1% to 1% by the end of 2022; and only after which point would it also consider dialing back the quantitative easing measures[4]. Given the UK’s weaker growth momentum compared with that of the US, raising interest rates prematurely runs the risk of stifling budding signs of economic growth.

While the EU has exhibited a slower recovery rate, not unlike the UK, European Central Bank Executive Committee member Philip Lane recently pointed out that it is cognizant of the region’s pressure points: the lack of a unified fiscal policy, high debt levels among many countries, and a yet-to-recover economy, so it would remain mindful of the pace at which it tightens its monetary policies[5].

As for China, the laggard economic data it printed recently has raised the likelihood of the country easing its monetary policy. Having said that, we think that the authorities would implement easing measures with control, with bank loans targeting specific industries to prevent speculative activities in the property market.

As things stand, the US looks to be the first to tighten its policies among Western countries, pointing to a potential appreciation of the US Dollar Index. Given the dollar’s role as a reserve currency, the implications of rate hikes and a stronger dollar are multifold. Here are several scenarios we think would play out:

Non-dollar denominated commodities will first see their prices rise as global raw materials and precious metals are all priced in USD, leading to a decline in demand and weighing down their prices.

Also, the tightening of monetary policies will translate to fewer investors using precious metals to hedge against the risk of excessive money supply as precious metals prices are closely tied to the US’s monetary policy. It’ll also strain their prices as a result.

Lastly, interest rate cuts in the US would typically lead to an outflow of the dollar as investors seek higher returns abroad, which would benefit emerging markets. But if the US does stop buying bonds mid-next year as expected, emerging markets economies will likely come under pressure – we think investors should be mindful of how such impact gets transmitted.

[1] Source: Fred Economic Data, as of Nov 2021

[2] Source: Federal Reserve press release, as of Nov 2021

[3] Source: Board of Governors of the Federal Reserve System, as of Nov 2021

[4] Source: Bank of England, as of Nov 2021

[5] Source: European Central Bank, as of Nov 2021

Disclaimer

This document is based on management forecasts and reflects prevailing conditions and our views as of this date, all of which are accordingly subject to change. In preparing this document, we have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public sources. All opinions or estimates contained in this document are entirely Zeal Asset Management Limited’s judgment as of the date of this document and are subject to change without notice.

Investments involve risks. Past performance is not indicative of future performance. You may lose part or all of your investment. You should not make an investment decision solely based on this information. Each Fund may have different underlying investments and be exposed to a number of different risk, prior to investing, please read the offering documents of the respective funds for details, including risk factors. If you have any queries, please contact your financial advisor and seek professional advice. This material is issued by Zeal Asset Management Limited and has not been reviewed by the Securities and Futures Commission in Hong Kong.

There can be no assurance that any estimates of future performance of any industry, security or security class discussed in this presentation can be achieved. The portfolio may or may not have current investments in the industry, security or security class discussed. Any reference or inference to a specific industry or company listed herein does not constitute a recommendation to buy, sell, or hold securities of such industry or company. Please be advised that any estimates of future performance of any industry, security or security class discussed are subject to change at any time and are current as of the date of this presentation only. Targets are objectives only and should not be construed as providing any assurance or guarantee as to the results that may be realized in the future from investments in any industry, asset or asset class described herein.