JD.com Has Posted Another Loss — 7 Charts on Why It's So Hard for Its E-Commerce Business to Make Money

In the end, it comes down to whether users have built a shopping habit on JD.com

After one profitable quarter, JD.com is back in the red.

On Monday, JD.com announced its financial figures for April through June this year. In this quarter, which took in the 6.18 shopping festival, revenue reached 93.2 billion yuan, up 43.6% from a year earlier. That number, a record since the company was founded, owes a lot to the 6.18 ads you couldn't get away from over the past two months.

But JD.com also lost 287 million yuan. Its stock fell 4.1% over the past two days, wiping out more than $2.5 billion in market value.

Last quarter's profit had made it look as though the cash burn was finally over, and JD.com had nearly caught up with Baidu. Now Baidu is $15.5 billion ahead of it in market value again. BAT may be missing a B, but it doesn't look like turning into JAT anytime soon.

Why is it so hard for JD.com to make a profit — or, like its model Amazon, to convince investors it could make one whenever it chose?

The numbers in the earnings report tell the whole story.

JD.com says it made a profit. What's going on?

The earnings report carries two profit figures:

1. Under U.S. Generally Accepted Accounting Principles (GAAP), JD.com lost 287 million yuan in the second quarter.

2. Not going by that (non-GAAP), JD.com earned 976.5 million yuan in the second quarter.

The gap between them is 1.26 billion yuan.

JD.com's earnings report leads with the GAAP loss of 287 million yuan. But in the press release it sent out, JD.com put its net profit for the quarter at 976.5 million yuan — close to its net profit for all of last year.

So what is the difference between the two standards?

Put simply, non-GAAP means a company reports by its own rules. That doesn't make it a lie: a company can, for instance, strip out acquisitions, sales of assets, and investments that have nothing to do with its main business, so readers can see more clearly how the business is running.

But what JD.com added back after adjusting its accounting is a different matter. Most of the 1.26-billion-yuan gap — 747 million yuan — comes from the equity the company grants to employees, especially executives. Beyond that, its other adjustments include acquisition costs and investment write-downs.

Under GAAP, equity grants count as a company expense. To be fair, JD.com's shares aren't cashed out the moment they're issued, and handing out stock cuts the company's cash spending. When Richard Liu announced in 2015 that he would take an annual salary of one li — a thousandth of a yuan — JD.com gave him stock worth more than $430 million at the time.

But in the end, equity grants exist to hold on to employees, especially executives.

Warren Buffett has weighed in on this. He sees no reason for companies to dodge what GAAP says about stock compensation. As he wrote in one of his shareholder letters: "If stock compensation isn't an expense, what is?"

This quarter, JD.com's spending on executive stock grants rose 50%. Measured by GAAP, which is the right way to judge JD.com, the company is still losing money.

The other reason not to be optimistic about JD.com's progress is how 6.18 went.

JD.com sold a lot during 6.18, but the festival still isn't a habit people take up on their own

"We at JD.com need an online shopping holiday of our own, something like Double 11. At this stage, promotions and price wars are still the best way for an e-commerce platform to draw a crowd." That is how JD.com explained the idea behind 6.18, years ago.

June has since become the season when every e-commerce platform piles in. Over the past few years, Suning.com, Dangdang, Yixun, Amazon China, and Gome Online have all launched mid-year sales in June, turning it into a second battlefield after Double 11.

This year NetEase Kaola and NetEase Yanxuan joined in too. NetEase's own figures show that Kaola's cross-border shopping business grew 500%, its best showing since it launched in 2015.

Alibaba came on strongest. Since joining the June push in 2013, Tmall and Taobao have put more into it every year. This year they rolled out the slogan "Ideal Life Festival" early, trying to loosen the link between JD.com and that date on the calendar.

This year, JD.com published sales figures for the 6.18 period for the first time. In earlier years, what it released were lines like "as of such-and-such an hour, sales passed last year's total" or "up 250% from last year."

The second quarter is JD.com's most important quarter every year. With this year's 6.18 promotion, gross merchandise volume (GMV) for the quarter reached 234.8 billion yuan, up 46% from a year earlier, about half of it during the 6.18 sale itself.

As of midnight on June 18, 2017, the cumulative value of orders placed for 6.18 reached 119.9 billion yuan, almost matching Alibaba's 120.7 billion yuan on last year's Double 11.

But the two companies paid very different prices to build their festivals.

During Double 11, every 100 yuan of Alibaba revenue took only 61.2 yuan of spending — more than 10% below what it spends the rest of the year.

JD.com spent more during this year's 6.18 than it normally does: 86.4 yuan of spending to bring in 100 yuan, 2-3% above its usual ratio.

Which is to say Double 11 has become a habit for shoppers, and 6.18 has not.

A Nielsen report last October found that 83% of people knew about the Double 11 shopping festival.

For 6.18, JD.com still has to spend heavily on marketing to remind people that this is a day for buying, buying, buying.

This quarter, JD.com's marketing spending rose 63%, from 2.5 billion yuan a year ago to 4.1 billion yuan.

JD.com is moving goods faster, and gaining more bargaining power with it

For an e-commerce company, profit isn't the only number that matters. Cash flow often matters more.

When JD.com sells something, the customer pays at once, but JD.com can wait weeks before paying the merchant.

The faster it sells, and the longer it takes to pay merchants, the more money it has to work with. Even with some losses, as long as it keeps growing, the cash won't run out.

JD.com's inventory cycle has held at just over 30 days from 2014 until now.

That is while it keeps adding categories and building out JD Supermarket to sell things like seafood. Against Amazon's 44-day inventory cycle, JD.com clearly turns its goods over faster, which also brings cash back faster.

Selling goods faster gives JD.com more say with its suppliers. Growing along with that is the time it takes to pay them.

The earnings report shows that in 2017 JD.com's payment cycle stretched from 49.3 days last year to 56.3 days, meaning it can wait another week before wiring cash to suppliers. Over a year, that lets it put the same pool of money to work one more time.

On this measure JD.com still trails Amazon, which dominates e-commerce in several countries. Amazon now takes 81 days to pay suppliers. At Christmas it can stretch that to 105 days.

Then again, Amazon has the U.S. e-commerce market to itself, while JD.com has to contend with Alibaba. Every 6.18 or Double 11, the two fight an "either/or" battle over which platform merchants will sell on.

Stretching its payment terms that far hasn't been easy for JD.com.

For an e-commerce platform, longer payment terms mean better cash liquidity. Money that sits in the company's hands rather than the suppliers' is worth more to the business: it can be invested, spent on warehouses and delivery, or used to buy more stock.

JD.com's cash flow got bigger, but it isn't as good as it looks

At the company's annual meeting in February 2017, Richard Liu said that by the end of last year JD.com could even let its buying and sales staff settle accounts early, simply because the company had enough cash. It was JD.com telling its cash-flow story once again.

One highlight of the second-quarter report was free cash flow of 20.31 billion yuan for the quarter. CFO Sidney Huang stressed the point on the earnings call.

Of the 33.3 billion yuan JD.com added this quarter, 29 billion went into investments, leaving net cash flow up just 4.3 billion yuan. The same period last year was 5.3 billion.

Free cash flow is an important number, one analysts often use to measure how efficient and how healthy a company is.

JD Finance had been costing JD.com enormous losses, swinging the parent company's cash flow between positive and negative. Last November, JD.com announced it would spin JD Finance off into a separate company.

The announcement said the move was meant to "facilitate certain financial businesses that foreign capital is barred from taking part in" and to "make better use of capital from China's capital markets." But the bigger reason for spinning off the finance business was to cut losses.

The spinoff was completed in the second quarter. JD Finance's numbers no longer appear in JD.com Group's statements, and its past numbers have been reclassified as discontinued operations in the group's consolidated accounts. From now on, what JD.com pays JD Finance will show up in the earnings report as fulfillment costs — subsidies for the Baitiao installment-credit product, for example.

JD.com plans to book the 14.2 billion yuan it received for JD Finance as additional paid-in capital. Because the payment paperwork is still with the State Administration of Foreign Exchange awaiting the standard administrative filing for cross-border payments, JD.com has booked only part of it so far. Under U.S. accounting rules, changes in additional paid-in capital show up under cash flow from investing activities.

Counting other financing proceeds, JD.com took in 16.5 billion yuan through investing activities.

Most of that money is already spent — JD.com put 29 billion yuan into investments in the second quarter. That leaves net cash flow up only 4.3 billion yuan for the quarter, against 5.3 billion a year earlier.

JD.com would rather investors look at its trailing-12-month free cash flow of 28.9 billion yuan, up 214% from a year ago. But its cash position is not as comfortable as that number sounds.

JD.com's CFO says the newly separated logistics business still isn't making money

On the morning of April 25, JD.com announced a logistics subsidiary group, with JD Logistics running independently. Wang Zhenhui, formerly a senior vice president of JD.com Group and head of JD Mall's operations, became CEO of the logistics subsidiary group, reporting to JD.com chairman Richard Liu.

At the time, a JD Logistics staff member told QDaily that the subsidiary group did not rule out raising money on its own or going public later, but had no concrete plans for either, and that setting up the subsidiary group had nothing to do with a spinoff or an IPO.

By Richard Liu's own account, the logistics business will take in $600 million from third parties this year.

Profit is another matter. On the earnings call (English transcript here), Blue Lotus Research analyst Wen Tianli asked how big JD Logistics' revenue was. Sidney Huang said the company had no figures yet on the unit's profit or loss, but that the logistics services it sells to third parties were roughly breaking even.

In the Chinese version of the call transcript, both the question and the answer were cut.

In chasing Alibaba, JD.com's biggest success has been signing up new users

In March 2014, JD.com and Tencent reached a strategic partnership, with Tencent taking a 15% stake in JD.com. In May, JD.com Shopping went live at a top-level entry point inside WeChat. In the fourth quarter of 2014, 20% of JD Mall's new users came through the shopping entries in WeChat and mobile QQ. The two have stayed close partners since.

Last September, JD.com announced a deal with Toutiao. The project, called the "JD-Toutiao Plan", put a JD.com shopping entry inside Toutiao and recommends product ads based on what users read.

The most recent large internet company to sign with JD.com is Baidu, which added a top-level "JD.com Exclusive" entry to the personal center of its mobile app, recommending ads based on Baidu's search data.

"Before the end of this month, we'll launch a new plan with another internet company. Through our alliance with four major internet companies, we can make sure we reach 100% of Chinese consumers," Richard Liu said on the earnings call.

Since the Tencent partnership began in early 2015, JD.com's user numbers have jumped.

This quarter, JD.com reported 258 million active buyers over the past 12 months, up 37% from a year earlier.

But over the past three years, how often people buy hasn't changed

From the transaction values and buyer counts JD.com publishes, we can work backward to see how many times each person bought something on JD.com over 12 months, and how much they spent.

In the 12 months ending June 30 this year, the average JD.com user shopped there 8.1 times and spent 3,036 yuan.

Looking on the bright side, what a JD.com user spends on one purchase is about what an Alibaba user spends in a year and a half.

The problem is that over the past two and a half years, how often JD.com users shop hasn't moved at all. However many new people JD.com pulls in, the average still works out to about 8 times a year.

Three months ago, when Alibaba CEO Daniel Zhang released the company's annual results, he called Alibaba "an economy with 507 million mobile users and 3.8 trillion yuan in GMV." That economy runs on what its users buy. In the first quarter of this year, 423 million people shopped on Alibaba's e-commerce platforms, and average spending per person rose 32.8%, from 189 yuan to 251 yuan.

That figure is far below JD.com's, but it is growing much faster.

Meanwhile, as Taobao and Tmall start talking about how many people come in and buy each month, JD.com still only says how many bought something over the course of a year.

The only reason not to publish monthly numbers is that they don't look good enough.

The difference is that users have built a shopping habit on Taobao and Tmall. They may spend less, but they look often and buy often. JD.com hasn't built that habit, so it still has to lean on constant promotions and fast delivery to get people to buy, and its sales costs won't come down.

Over these three years, JD.com has tried plenty of things to build that habit:

From January 2016, JD.com made fresh food a top-level business unit, to draw shoppers into a category they buy from more often and stick with. JD Supermarket, meanwhile, became the focus of the consumer goods unit.

JD.com announced that its goal was to run the No. 1 supermarket business, online and offline, within three years.

E-commerce growth has slowed, and e-commerce companies large and small have tried all sorts of ways to get users to open the app more often and stay longer — building content is one, moving into supermarkets and fresh food is another. Over the past year, the supermarket business — bought from more often, and a source of more traffic for a platform — has become a new battleground between JD.com and Tmall. This quarter's report shows GMV for daily necessities and other categories up 55% from a year earlier.

Like Alibaba, JD.com has also put its hopes for growth offline.

Not long ago, JD.com laid out that plan: 300 physical retail stores across the country. Earlier this year, Richard Liu said JD.com would work with a million convenience stores nationwide, half of them in rural areas — in practice, putting up signs for the corner shops of China's county towns with the JD.com name on them. The same day, JD.com said it would build 5,000 maternal-and-infant experience stores within three years.

JD.com has also copied Amazon's Prime with its own Plus membership, hoping discounts, waived shipping, and points will get users to buy more on JD.com. But in this earnings report and the call that followed, JD.com said nothing at all about what Plus has done.

Then there's Baitiao. At bottom, Baitiao is JD.com lending users money to buy things. On any product JD.com sells itself, as long as you don't split the payment into installments, you get roughly a month of interest-free credit, with JD.com covering the interest. During promotions, many products come with six months or even a year interest-free.

According to JD.com's earnings report, Baitiao receivables still stood at 15.2 billion yuan as of March 31, 2017.

All of this is what JD.com pays to attract users.

After the first-quarter results came out this year, Richard Liu told interviewer Lang Yongchun: "If our profit for the year is a billion yuan, a few hundred million, that to me is really not profit. I always say, any time our annual net profit is below 10 billion yuan, don't talk to me about calling it profit — that isn't profit."

If users never build that habit, steady profit will indeed be no easy thing for JD.com.

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