I have a new favorite Chinese stock, and it has everything to do with the largest retailer in the U.S.
That would be Wal-Mart (WMT), which is also a big international seller—the company gets about a third of its sales from outside the U.S. To date, however, Wal-Mart hasn’t been able to crack China.
Sure, the company has well over 400 stores in China, but walk-in foot traffic at those locations has been going down for nine straight quarters.
Why hasn’t the Wal-Mart mega-store strategy worked in China?
There are a ton of answers, but the three biggest are:
1) Chinese consumers are buying more and more of everything online, and Chinese retailers are offering one-day delivery in big cities and adding more smaller cities to their delivery networks.
2) Wal-Mart’s U.S. pricing advantages don’t work as well in China, where price competition is cutthroat in the extreme.
3) Chinese rivals have a size advantage as huge online user bases in one area (search, e-commerce, messaging and games, for instance) can be leveraged as a foundation for other enterprises.
So it wasn’t much of a surprise to read on Monday that Wal-Mart is making a major strategy shift in its Chinese operations, selling Yihaodian (its online commerce marketplace) to JD.com (JD).
Wal-Mart first took a stake in Yihaodian—which specializes in groceries and other items of interest to affluent female customers—in 2011, then acquired full ownership in 2014. But with Yihaodian’s Chinese e-commerce market share at less than 2%, the enterprise clearly was not thriving, at least not up to Wal-Mart’s standards.
A Good Deal for Wal-Mart
The sale of Yihaodian to JD.com will bring Wal-Mart into partnership with JD.com, a strong direct seller to Chinese consumers. Wal-Mart’s 5% stake in JD.com is valued at $1.5 billion based on JD.com’s current stock price. The partnership is a good bet, because JD.com has been slowly prying market share away from Alibaba (BABA).
The tie-up between the two companies will give Wal-Mart’s physical stores access to JD.com’s delivery network of warehouses and vehicles, plus a listing on JD.com’s websites.
JD.com has spent a huge amount of money to strengthen its delivery infrastructure, mimicking Amazon’s (AMZN) strategy of building for the future rather than booking big earnings numbers.
I think Wal-Mart has made a good decision with this deal. The online giants in China look too strong for any foreign competitor to challenge. So rather than wasting time and money in that battle, Wal-Mart has chosen to ally itself with an established and successful player, one that has shown that it can make long-term inroads against the online titans.
Wal-Mart’s stock reacted positively to the news, although it’s still trading in a tight, gradually rising consolidation pattern after its May 19 gap up on earnings.
Based on this story, I might be tempted to make WMT my stock pick of the day. The stock fell from 91 last January to 56 in November, but has made good progress from its bottom. After a bad year in 2015, it trades at a reasonable 16 P/E and its dividend offers a solid 2.8% annual yield. Even though the stock is trading at its August 2013 price, it has near-term momentum, which is a valuable signal.
Even Better Deal for JD.com
But my real enthusiasm is for the other party in the big deal I’ve been writing about. JD.com has been spending for the future and grinding out gains in market share, so it doesn’t have great earnings numbers. It doesn’t pay a dividend and doesn’t have a P/E ratio. In other words, it’s a growth stock, rather than a blue-chip dividend stock like WMT.
I wouldn’t even be a buyer right here. The chart doesn’t show the kind of upward movement that indicates improving perceptions on the part of investors. Here’s a weekly chart that shows the Chinese stock’s entire trading history since it came public in May 2014. Not too tempting.
JD.com is a company that’s suffering from comparison with Alibaba, Tencent Holdings (TCEHY) and Baidu (BIDU), all of which have better earnings histories and bigger market caps.
But JD.com is a real sleeper, a patient company with a clear strategy and enormous potential.
When JD gets going (which may not happen until investors get comfortable with Chinese stocks again), the upside could be huge. Everything is ready for the stock to explode, you just have to put it on your watch list and wait for a rising price and rising volume to give the signal.
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