China e-commerce boom fires-up logistics sector
As the battle between China’s e-commerce giants heats up, the country’s logistics operators – and ...
“What we need to do is always lean into the future, when the world changes around you and when it changes against you – what used to be a tail wind is now a head wind – you have to lean into that and figure out what to do, because complaining isn’t a strategy,” Jeff Bezos
The shares of Alibaba and JD.com, the first- and second-largest e-commerce players in China, have enjoyed spectacular runs in the past 12 months. But as these two disruptors continue to grow their core on- and off-line retail offerings while rolling out new services almost daily, their logistics plans deserve a good, hard look – particularly now that the IPO of JD logistics is looming.
Combined, Alibaba’s $483bn market cap and JD’s $66bn dwarf the market values of two of the most prestigious and leading players in the west, equating to about 30 times Kuehne + Nagel (K+N) and 50 times the market cap of Expeditors. It is no coincidence, in my opinion, that K+N recently announced a joint venture with Singapore state investor Temasek “to invest in early stage companies developing cutting-edge technology for logistics and supply chains”, while we all know how important Asia is for Expeditors in terms of sales.
If we take into account the share performances of K+N and Expeditors and compare them against Alibaba and JD, equity capital markets trends only partly capture the extent of the challenge for the freight forwarders faced with deteriorating cash flows from operations due to persistent core margin erosion, which is mainly due to less profitable volumes and higher operating costs.
The rise of global shippers aiming to shake up the transport and logistics (T&L) industry should concern the middle-man rather than air and ocean carriers, because many of the world’s largest e-commerce players could use T&L services – just as Amazon does with other retail services to boost its core Amazon Web Services activities – to win market share where heavy investment is less necessary. This approach could lead to an accounting loss for the retailers but expand profits in other sectors where the tech slant of their products usually prevails. Sadly, freight forwarders can hardly afford it, based on traditional business models that are only slowly changing.
The opportunity cost of such a strategy is what drives value and economic profit rather than what, in this context, is a less important element: accounting income (emphasis mine).
This aspect plays a central role, not only because Alibaba’s accounts are murky at best, but also because the hangover in China has yet to appear 10 days ahead of new year celebrations, and the latest news concerning JD Logistics’ IPO reinforces the view that significantly higher cost of equity, which brings higher hurdle rates for industrial projects, will unlikely be a problem for either Chinese company.
JD “has invited a select group of investors to join the funding round that values its logistics business, JD Logistics, at around $10bn”, according to Reuters, and this could release hidden value from its logistics activates as it continues to exploit deeper ties with DP-DHL, among others, on several fronts, worldwide.
JD is pushing for US expansion at a time when Alibaba is reportedly in talks with US grocer Kroger, which has been under pressure for a couple of years and is looking for options to limit the damage brought by the actions of bigger and more powerful outliers in traditional retail operations, in a domestic market where one of its competitors, Whole Foods, was acquired by Amazon for almost $14bn last summer.
This strategy in the US brings risk, but so long as consumer spending keeps rising at record rates and consumers remain unworried about tapping into their savings accounts, it appears a good strategy. If you trust the major integrated logistics companies – FedEx, UPS, and DP-DHL, all maintaining a competitive advantage, given their economic moats – projected CPI numbers should help shore up the plans of those who want to capture precious market share in a buoyant market, while diversifying their offering into the T&L arena.
Enter JD Logistics, and its IPO – the Chinese group said in November that during the third quarter, “JD Logistics test-launched its first unmanned sortation centre, the first of its kind in the logistics industry”. Meanwhile, it also wrapped up “a series of agreements to lay the groundwork for the rollout of China’s largest and most advanced drone network”.
It added: “As the company expands the capabilities of JD Logistics, it will continue making its technology infrastructure and services available to businesses across a wide range of industries”.
JD has close relationships with many of the major shippers in the US. As it said, it “expanded its environmentally friendly logistics and packaging campaign”, teaming up with P&G, Nestlé, Unilever, Lego, Kimberly-Clark, Watsons, Erie and Johnson & Johnson, to name a few, while looking “to minimise environmental impact by reducing the overall use of packaging materials. JD estimates that the campaign will save billions of cardboard boxes over the next three years”.
JD Logistics said it provided “scheduled delivery service in 250 Chinese cities, allowing customers to choose a convenient two-hour delivery window in which to receive their goods”, having switched from supporting the parent’s platform to an independently operated business unit – it says the “cost related to the logistics services provided to merchants and other third parties are reclassified from fulfilment expenses to cost of revenues”.
Regardless of how much equity it plans to sell, applying normal trading metrics that would suit most T&L operators, the enterprise value (EV) of JD Logistics should be worth $10bn (whether or not the spun-off entity carries any debt) based on $10bn/$15bn of annual sales, yielding about $500-$700m of adjusted operating cash flows.
(As a reference, an asset-light business such as CH Robinson, which reported a poor trading update last week, reported annual gross sales of about $15bn, and a trailing EV/sales multiple of 0.9x.)
These are the numbers you’d expect if JD Logistics was a traditional asset-light transport operator, one for which sales multiples that cater to global integrated logistics players – barring UPS, one of the most richly valued entities, with a 1.8x EV/sales multiple, but that is UPS – generally apply.
But if Reuters is correct, and the numbers I sighted are also correct, JD stock could trade well over 2x revenue, given just about $4.5bn of annualised sales. If that is the case, I suspect JD Logistics could be barely in the black, and generating little free cash flow, if any – yet investors may well dismiss those metrics, lured by growth projections. In fact, the question is how big it will become over time, and making certain assumptions (JD predicts the unit’s revenues will triple by 2022) it could take just up to five years for JD Logistics to generate adjusted cash flow commanding a multiple that would make its equity worth multiple times $10bn.
Reuters recently wrote that JD.com “posted net earnings of Rmb1bn ($151m), its highest-ever quarterly profit, in the three months to September 30, confounding analysts’ forecasts of a Rmb213m loss”, and nine-month figures for operating cash flows at group level were pretty strong. Also, in the comparable quarter of 2016 the loss was meaningful, so trends are surely encouraging, to say the least, if you trust its accounting.
We will know the answer when the IPO hits the market – likely before the usual spring window – and then it will be all about how its much bigger domestic rival reacts.
In September, Alibaba took control of logistics unit Cainiao and pledged to spend Rmb100bn ($15bn) over five years “to build out a global logistics network, underscoring aggressive expansion plans overseas”, Reuters reported at the time. At the turn of this year, the headline was that it had invested $100m – significantly more than annual capex budgets for CH Robinson and Expeditors – in a logistics start-up called XpressBees, which is a relatively small amount when compared with a $360m commitment in Haier Electronics four years ago, a deal that was aimed at forming a logistics joint venture.
China’s Haier Electronics and its logistics plans have attracted interest, too. Speculation has been doing the rounds since last summer, when DBS analysts “noticed Haier Electronics’ intention to realise the value of its high-growth logistics unit (Goodaymart Logistics), with a series of corporate exercises, which include the separate reporting of logistics unit since Q4 16 (previously combined together with channel services division, known as ICS – Integrated Channel Services division) and CB conversion of Alibaba into holding a 34% equity stake. We understand that the final target is to have a separate listing of the logistics unit”.
In a T&L sector that is moving faster than ever (Amazon is making a push to reach a market value of $1trn, from $690bn currently), last week the shares of US trucking firm YRC Worldwide plunged 22% in a single trading session on Friday, following a trading update which simply confirmed that the financially weaker players (and yes, YRC is one of the them) are out of favour with investors, whose preferences will likely continue to shift towards new entrants boasting stellar growth prospects as well as more deeply diversified and structured portfolios.
Unless, that is, the largest asset-light players come to terms with the idea of finding a way to join forces as well as more creative ways of doing business.