Should You Buy Baozun at its All-Time High?

Markets Motley Fool

Shares of Baozun (NASDAQ: BZUN) have rallied about 30% this month as investors apparently realized that the company's post-earnings sell-off in late August was unjustified. Baozun is often called the "Shopify (NYSE: SHOP) of China" since it similarly acts as a "one-stop shop" for a retailer to establish an online presence.

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Baozun crushed analyst estimates on the top and bottom lines last quarter, but the stock plunged after investors took profits. But Baozun then rebounded and extended its 210% year-to-date rally, presumably on a short squeeze (about 30% of shares are still being shorted) and bullish interest in Chinese tech stocks.

So should investors chase that rally and buy the stock at all-time highs? Or should they wait for Baozun to cool off to more "reasonable" levels?

Why the bears misunderstood Baozun

Baozun isn't as well-known as the BAT group (Baidu (NASDAQ: BIDU), Alibaba (NYSE: BABA), and Tencent (NASDAQOTH: TCEHY)) of established Chinese tech stocks. As a result, Baozun is often considered a riskier Chinese play -- which likely doesn't sit well with institutional investors.

Some bears also believe that e-commerce giants like Alibaba could eventually render Baozun obsolete by offering similar storefront services to offline retailers. However, that thesis overlooks the fact that Alibaba is one of Baozun's top investors, and that Baozun's platform is already deeply integrated with Alibaba's Tmall and Taobao. Baozun's services also connect retailers to JD.com and Amazon (NASDAQ: AMZN) -- which essentially makes it the "gatekeeper" of China's booming e-commerce market.

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Baozun follows almost the same growth trajectory as Shopify. In the early days, the bears also claimed that Amazon could render Shopify obsolete. However, Amazon eventually partnered with Shopify and integrated its services into its ecosystem. But Shopify isn't consistently profitable, while Baozun has reported profits every quarter since its public debut in 2015.

What the valuations tell us now

Wall Street expects Baozun's revenue and earnings to respectively rise 20% and 105% this year, followed by 22% revenue growth and 62% earnings growth in 2018. That growth should be supported by an increasing number of retailers moving their businesses online, along with the introduction of new value-added services in vendor tools, marketing, customer service, and logistics.

Baozun's trailing P/E of 114 admittedly looks high relative to its earnings growth and the industry average of 44 for specialty retailers. But its forward P/E of 34 looks reasonable, and indicates that the stock could actually be undervalued relative to its earnings growth potential.

What potential headwinds does Baozun face?

These facts all make Baozun look like a great growth stock, but it still has flaws. Anything that hurts Alibaba and other e-commerce players -- like an economic downturn in China or softer consumer spending -- could throttle Baozun's growth. The evolution of Tencent's WeChat, the top messaging app in China, into an O2O (online-to-offline) ecosystem is also troubling, since it could directly connect businesses to shoppers without Baozun's help.

Baozun is also burning through lots of cash. Its cash and equivalents fell from 917.3 million yuan ($140 million) at the end of 2016 to just 589.2 million yuan ($87 million) at the end of the second quarter. Baozun attributes that decline to investments in logistics, and those costs could keep rising as the company expands.

Operating expenses rose 22% annually to 96% of Baozun's revenues last quarter, led by higher marketing and fulfillment expenses. If Baozun's rising expenses eclipse its revenue growth, its bottom line could eventually dip into the red. Nonetheless, Baozun's operating cash flow remains positive for the first half of 2017, versus a negative figure in the first half of 2016.

Should you buy Baozun today?

I personally bought shares of Baozun after its post-earnings dip, but I'm well aware that it's a volatile stock.

Investors who can't stomach that volatility might be better off looking into better known Chinese stocks like Alibaba -- but investors who are willing to ride out Baozun's price swings could enjoy some great growth from the lesser-known stock.

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Leo Sun owns shares of Amazon, Baidu, Tencent, and Baozun. The Motley Fool owns shares of and recommends Amazon, Baidu, JD.com, and Shopify. The Motley Fool has a disclosure policy.