Can JD Industrial become a bull stock?

The sudden surge in the market has changed the spirit of China's two major capital markets. As the leader in the global market, the Hong Kong stock market has also become active again in terms of IPOs.

JD Industrial, originating from the JD.com system, is the largest MRO procurement service provider in China. In the first half of this year, the company achieved a profit of 291 million yuan, turning losses into gains compared to the same period last year.

With the current performance different from the past, JD Industrial is also looking to successfully go public in this bullish market, making a second attempt on the Hong Kong Stock Exchange after 18 months.

MRO is a mature and stable business that is worth long-term operation and has been recognized in the capital market. The global MRO leader, Grainger, is a well-known stock in the industry, with a current market value exceeding 50 billion US dollars.

With industry guidance, JD Industrial, which is reapplying for listing, seems to have the potential to become a bullish stock. In the current market where missing out is more painful than being trapped, is JD Industrial a bullish stock that cannot be missed?

I. Bullish Stock Genes

Choosing the right business model in the correct track is the only bullish stock gene for JD Industrial.

Its significance lies in connecting suppliers and customers end-to-end through the e-commerce platform represented by JD Group, providing stable sources and efficient inventory management solutions for enterprises of various sizes, helping customers reduce production and operation costs.

The company's business model belongs to online procurement, where most orders are directly shipped from the supply side to the demand side, without producing products themselves, and operates on a light-asset model.

Currently, the company's business includes two parts: revenue from product sales and service revenue. From 2021 to 2023, the company's revenue was 10.345 billion yuan, 14.135 billion yuan, and 17.336 billion yuan, with a compound annual growth rate of 29.4% during this period.

Among them, product sales revenue was 9.472 billion yuan, 12.9 billion yuan, and 16.12 billion yuan; service revenue was 0.873 billion yuan, 1.199 billion yuan, and 1.216 billion yuan.

The gross profit margin of service revenue is relatively high, but it has not played a decisive role yet due to its small proportion. It is the pillar business of the overall performance to maintain high-speed growth, driven by the nearly 30% CAGR growth in product sales revenue.

General MRO is the largest sub-category in product sales revenue. This category belongs to non-production raw materials industrial supplies, which are crucial for maintaining the normal operation of production equipment. Common MRO products include maintenance tools, lubricants, and safety protection supplies Due to its universal application, the demand for MRO products has been almost constant and sustainable in many industries. Moreover, due to the industry characteristics, enterprises mainly selling general MRO products have relatively high average ROE.

This is because: 1. From the perspective of asset turnover, these products are highly standardized and mostly consumables, with enterprises making purchases every half year or once a quarter. With fast turnover inherently, platforms providing procurement services for these standardized products will also have a fast asset turnover rate. In 2023, JD Industrial controlled its inventory turnover days at 13.8 days.

1. In terms of financial leverage, based on the transaction volume in 2023, JD Industrial is the largest MRO procurement service provider in China, with a market size twice that of the second place. This industry position enables JD Industrial to have the ability to not be constrained by downstream and to use a large amount of upstream funds to amplify ROE.

3. In terms of profit margin, another characteristic of highly standardized products is that profits increase with scale expansion. After achieving significant economies of scale, the larger the sales volume of general MRO products, the higher the gross profit margin.

Doing business in such a market with almost perpetual demand is choosing the right track; operating in a light asset manner is also choosing the right business model. This is currently the most prominent bullish gene of JD Industrial.

Customer focus on product quality, SKU variety, logistics distribution, etc., are also strengths of JD Group, and naturally, JD Industrial within the JD system is more competitive, with a market scale that sets it apart from its peers.

However, the formation of bullish genes is not as simple as choosing the right track and business model. The industrial sector is closely related to a country's economy, and with different national conditions, the formation of bullish genes will also vary greatly.

II. Different National Conditions

In terms of transaction volume, the market size of China's MRO procurement services in 2023 is 3.5 trillion yuan, more than three times that of the United States. However, leading digitalized MRO procurement listed companies in the United States have an average gross profit margin of over 30% and an average net profit margin of over 10%. As of the first half of this year, JD Industrial's gross profit margin was only 16.9%, and net profit margin was only 3.4%, far below the average level in the United States.

Doing MRO procurement business in China is not as profitable as in the United States, obviously related to the national situation.

In August 2024, China's industrial producer prices fell by 1.8% year-on-year and 0.7% month-on-month; industrial producer purchase prices fell by 0.8% year-on-year and 0.6% month-on-month. It has been negative year-on-year growth for more than four quarters.

The fact that the purchase price decline is lower than the factory price indicates that the cost reduction is far less than the selling price, which may compress the profit margin of industrial production enterprises, even leading to losses. As a procurement supplier, JD Industrial's profit margin will not be too large either.

The U.S. Producer Price Index has generally been on the rise since the beginning of this year. From 2009 to 2024, the average producer price in the United States was 117.38 points. From 2016 to 2024, the average producer price index in China was 107.04 points.

One rising and one falling, one with a higher average index and one with a lower one, is one of the reasons for the revenue difference between the two countries' enterprises.

The different national situations will directly affect the emergence of high-growth stocks. The decline in domestic PPI index indicates that the current industrial production end is not optimistic, and the demand for MRO products will also decrease.

If the gap between the conflicting PPI indices cannot be narrowed, JD Industrial's difficulty in catching up with the profit margin of the top U.S. industry will only increase.

In 2022, when the domestic PPI entered a downward cycle, the company began to adjust its strategy due to the slower-than-expected development speed, focusing on maintaining core KA customers. However, emphasizing customer interests makes it difficult for the company to reduce costs and increase efficiency under the trend of slower-than-expected development speed.

3. Reasons for Investment

According to Guanajie's experience, a company with slowing growth needs continuous cash inflows to support dividends and buybacks to sustain long-term bull runs in stock prices.

Established in 1927, Guanajie is a global leader in MRO. From the industrial age to the Internet era, from World War II to the pandemic, the company has survived historical cycles and its stock price has continued to rise.

Over the past 20 years, Guanajie's compound revenue growth rate was 6.32%, and the compound net profit growth rate was 10.58%. Its net profit is almost the same as free cash flow, indicating very high operational efficiency. Therefore, even if the revenue growth rate is only in single digits, its ability to continue buybacks and dividends does not prevent it from becoming a high-growth stock This highlights the importance of reducing costs and increasing efficiency for enterprises.

However, the increase in revenue and profit achieved by JD Industrial in the first half of this year was not based on substantial cost reduction and efficiency improvement.

As of the first half of 2024, the company's total revenue increased by 20.3% from 72 billion yuan in the same period of 2023 to 86 billion yuan. Net profit was 290 million yuan, with a net profit margin of 3.4%, compared to a net loss of 190 million yuan in the same period last year, turning losses into profits year-on-year.

The increase in net profit is mainly due to the decrease in fair value changes of convertible preferred shares. Excluding the impact of these non-operating costs, while the gross profit margin continues to decrease, the performance expenses, sales and marketing expenses, and R&D expenses have not decreased overall during the same period.

This means that the customer acquisition cost of the company has not decreased, and may have even increased.

As a sister company, JD Logistics turned losses into profits in 2023 and has been profitable since then. From the performance in the first half of this year, it can be seen that JD Logistics has reduced the proportion of sales expenses, reduced general administration and R&D expenses year-on-year, achieving substantial cost reduction and efficiency improvement.

Maintaining the predictability of continuous profit growth is crucial for industries with slowing revenue growth. After the performance announcement, the market realized the sustainable profitability of JD Logistics, and the stock price started to rebound from August this year, coupled with the recovery of Hong Kong stock liquidity, it has been continuously rising. In contrast, JD Industrial, based on the current performance indicators, is not yet able to achieve cost reduction and efficiency improvement.

Fortunately, the company's cash flow remains positive, with the ability to reward shareholders in the future.

Although the data presented on the books shows that as of the first half of this year, JD Industrial's net cash increase turned from positive to negative. This is because the company took 2 billion to buy time deposits, offset by 1.8 billion when the time deposits matured, resulting in an investment activity of 220 million.

However, fundamentally, this part of the funds has not flowed out and still belongs to internal assets. The company also does not have a significant financing need, and its business model determines that there is no need to purchase a large amount of fixed assets such as equipment. This indicates that most of this money can be used to expand the business or reward shareholders.

For companies with mixed operating performance, the final investment decision still needs to be based on valuation.

According to data, like all its subsidiaries, JD Group has absolute control over JD Industrial. In the pre-listing shareholding structure, JD Group indirectly holds 77.32% of the shares; Liu Qiangdong indirectly holds 3.68%.

After completing 23 years of Series B financing, JD Industrial was valued at approximately $6.7 billion (about 47.03 billion RMB). The company's revenue in the first half of the year increased by 20.3% year-on-year. Considering that the PPI was still declining in August, it is conservatively assumed that the company's full-year revenue in 2024 will increase by 18% year-on-year, reaching 20.46 billion RMB. Calculated at a valuation of $6.7 billion, JD Industrial's PS ratio will reach 2.3 times in 2023.

Compared with peers, Shenkunxing, the second-ranked company in China that supplies MEO products across categories, has a PS ratio of 0.45; Xianheng International, which covers intensive supply of energy, transportation, and emergency MRO products, has a PS ratio of 1.5 times; Zhengfan Technology, which focuses on supplying semiconductor MRO products, has a PS ratio of 2.5 times, and the global MRO leader Guanajie has a PS ratio of 3 times.

JD Industrial's PS ratio of 2.3 times is relatively high in the industry, but its revenue growth has been slowing down since 2021, and given the PPI index, there is still a possibility of further slowdown in the future.

Therefore, the current PS ratio of JD Industrial in the range of 1-1.5 times is more reasonable, and the valuation in 2023 is significantly overvalued.

Fortunately, JD Industrial's sprint to the Hong Kong Stock Exchange for IPO is well-funded. The company's total assets are 12.063 billion RMB, with cash assets as high as 9.144 billion RMB, no explicit interest-bearing liabilities, accounting for a high proportion of 75.8% of total assets.

The large amount of convertible preferred shares not yet IPOed on the balance sheet temporarily distorts the balance sheet. However, the risk is lower than bank loans and does not affect normal operations.

There are no major issues with the fundamentals, and the well-funded IPO may result in a lower issuance of shares. If the post-listing valuation is lower than 1 times PS, it provides a higher safety margin. With positive cash flow and concentrated equity, the company will have more motivation to distribute dividends in the future, which gives it a certain investment rationale Conclusion

In the US stock market, one of the key elements supporting the long bull market is continuous dividends and buybacks, which is currently being replicated in the Hong Kong stock market. When JD Industrial, which has re-submitted its application to the Hong Kong Stock Exchange, becomes a beacon for future development like GoerTek by improving operational efficiency and maintaining sustained profitability, it should not hesitate to reward shareholders. Only when this logic is initially established can a bull stock be formed and sustained.

However, following the development path of GoerTek to replicate another JD undoubtedly poses significant challenges. Currently, attention should be paid to the company's IPO pricing, profitability, and changes in China's PPI index. If there is a significant expectation gap (a deviation between market valuation expectations and the company's actual expectations), then there is an investment opportunity