Shares of Vipshop (NYSE: VIPS) tumbled nearly 20% on May 15 after the Chinese e-tailer reported its first-quarter numbers. Its revenue rose 25% annually to 19.9 billion yuan ($3.2 billion), beating estimates by $120 million, but its non-GAAP net income dropped 9% to 728 million yuan ($116 million), or 1.05 yuan ($0.17) per ADS, missing expectations by a penny. But did Vipshop deserve to decline that much in a single day?
What does Vipshop do?
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Vipshop controlled about 3% of China's business-to-consumer (B2C) market last year, according to Analysys International Enfodesk, putting it a distant third behind Alibaba's (NYSE: BABA) Tmall and JD.com (NASDAQ: JD). However, Vipshop carved out a defensible niche with flash sales -- which helped it survive as its smaller rivals died out.
Last December, Tencent (NASDAQOTH: TCEHY) and JD co-invested $863 million in Vipshop. That investment -- which gave Tencent a 7% stake and boosted JD's existing stake from 2.5% to 5.5% -- was a strong vote of confidence for the underdog retailer.
The move integrated Vipshop's marketplace with Tencent's WeChat, the top mobile messaging app in China, and allowed Vipshop and JD to share their marketplace resources and forge strategic alliances with brand suppliers. In theory, those moves could help all three companies counter Alibaba.
What went right for Vipshop in the first quarter
Vipshop's 25% year-over-year sales growth during the quarter was supported by robust growth in active customers and higher spending per customer. Its active customers over the past 12 months rose 2% annually to 56.6 million. Its total orders climbed 25% to 90.2 million for the quarter, which also lifted its average revenue per customer by 25%.
Also, 86% of Vipshop's customers were repeat customers, up from 77% a year ago. And 96% of all its orders were placed by repeat customers, up from 92% a year earlier. Vipshop also enrolled 1.5 million customers into its Super VIP paid membership program, which represents 54% growth from the fourth quarter.
Vipshop's logistics network is also improving. It delivered about 99% of its orders via its in-house last-mile delivery network during the quarter, compared to 93% a year earlier. That service also handled 81% of customer returns, up from 67% a year ago. It also added a warehouse in Frankfurt, Germany, to expand its overseas network -- which also includes warehouses in Hong Kong, New York, Paris, Milan, London, Seoul, Tokyo, and Sydney.
Vipshop also tightened its bonds with JD and Tencent during the quarter. In March, it launched its co-branded JD flagship store, which attracted "approximately half a million followers within the first two months," the company said in its first-quarter press release. In April, it integrated a "mini-program" store into WeChat's platform -- which has about one billion monthly active users -- and launched special promotions for WeChat Wallet.
What went wrong for Vipshop
But for the current quarter, Vipshop expects just 17% to 22% annual sales growth -- which would represent its slowest ever growth rate. That's a disappointing figure for investors who had expected its partnerships with Tencent and JD to boost its long-term sales.
Meanwhile, Vipshop's bottom-line miss was partly caused by a decline in its gross margin, which dropped three percentage points annually to 20.2%. The reclassification of third-party logistic costs from fulfillment expenses to cost of revenues reduced its gross margin by 0.9%, while the rest of its decline can be attributed to pricing pressures across the e-commerce market.
Vipshop's operating expenses also rose 13% annually -- as higher fulfillment, technology & content, and general & administrative expenses offset a 12% reduction in its marketing expenses. As a result, Vipshop's free cash flow dropped from $429 million a year earlier to negative $217 million for the first quarter. Its cash and equivalents also fell from 9.97 billion yuan at the end of 2017 to 7.01 billion yuan ($1.12 billion).
Those numbers indicate that like its partner JD, which also recently disappointed investors with a bottom-line miss, Vipshop is spending money on the expansion of its digital ecosystem and logistics network to generate higher growth in the future. However, Vipshop's smaller size leaves it more vulnerable to competitors than JD -- which controls about a third of China's B2C market.
The bottom line
Vipshop's earnings miss was disappointing, but the stock arguably overheated after Tencent and JD's investment last year -- soaring from about $8 to nearly $19 in just over two months.
But after its post-earnings sell-off, Vipshop trades at just 14 times this year's earnings. That's a reasonable valuation compared to analysts' estimates for 26% sales growth and 12% earnings growth this year. However, I personally wouldn't rush in to buy Vipshop -- since Tencent and JD are clearly more stable long-term plays.
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