Against the headwind, can Alibaba, JD.com, and Meituan make a comeback?

Since May 1st, the stock performance of domestic e-commerce companies we cover, from the beginning of the first quarter earnings season until now, has been disappointing. Except for Pinduoduo, which has performed exceptionally well, and Alibaba Group, which has managed to achieve positive returns, the stock prices of other companies have not only declined but also underperformed the performance of the China Concept Stocks Index during the same period. It is undeniable that in the past five months, domestic e-commerce companies have shown weak performance in terms of absolute and relative returns.

Although it is expected that online retail will be eroded to some extent due to the recovery of offline consumption in the next few quarters after the epidemic, and the "internal competition" that has intensified again in March theoretically will also harm the industry's profits in the stagnant market, Dolphin Research did not have a positive outlook for the performance of the e-commerce sector in the market in the two industry overviews released before the year and in April.

However, as of October, although the stock performance has been disappointing as expected, the performance of key e-commerce companies in the second quarter has generally been better than expected. So why is there a discrepancy between the stock performance of companies and the industry, and based on recent developments, how will the industry and companies perform in the following quarters? Let's explore together with Dolphin Research.

Following is the detailed discussion:

I. Review of the performance of the e-commerce sector in the first and second quarters

1. After a long night, will the dawn finally break?

Compared to Dolphin Research's expectations at the beginning of the year, the performance of the domestic online retail market in the second and third quarters of this year (as of the end of August) has been relatively weak, at best, it can be considered "making the best of a bad situation". The bitter reality is that the compound growth rate of online retail (vs. 2021) has continued to decline in the first three quarters of this year, and the slowdown in growth is an undeniable fact. Dolphin Research's relatively conservative target of 11% annual growth in online retail for the entire year of 2023 is unlikely to be easily achieved.

However, it is somewhat comforting that unlike the US, where online retail penetration remained negative or zero growth for several quarters after the market was opened up, the online retail penetration rate in China has continued to rise, albeit at a slower pace, in the second and third quarters. Despite the adverse impact of offline recovery, the relative advantage of online retail leading the overall market is still evident.

Firstly, looking at the growth of the online retail market, based on the two-year compound growth rate from 2021 to 2023, the growth rate of the domestic online physical retail market in the first three quarters of this year (as of 3Q, August) has shown a clear trend of slowing down, with growth rates of 9.5%, 7.5%, and 6.8% respectively. The industry's prosperity is clearly deteriorating. However, the "ray of hope" is that in August, several domestic economic indicators showed marginal improvement, and the MoM growth rate of online retail sales also increased (from 6.5% to 7%). Although the growth rate is still lower than the level of over 9% at the beginning of the year, Dolphin Research believes (and hopes) that the economic and consumption situation in the remaining months of this year will not significantly improve, but at least it is unlikely to worsen. Moreover, at the end of last year, during the widespread spread of the epidemic, the base was also low, so the YoY growth rate of online retail sales in the fourth quarter of this year is expected to improve.

Referring to the experience of the United States after fully lifting epidemic prevention and control measures in mid-2021, the YoY increase in the penetration rate of online retail directly dropped from over 5% during the epidemic period to -1.1%, and it took five quarters of zero or negative growth to gradually recover to the pre-epidemic normal growth rate.

In comparison, the YoY increase in the penetration rate of online retail in China only dropped to 0.7% in the first quarter (1Q23) after the lifting of restrictions, and quickly recovered to over 1%. It can be seen that although overall consumer goods consumption is weak, online channels are still relatively outperforming.

2. Offline consumption is recovering, but food delivery may not benefit

Unlike retail goods, the catering and offline service consumption have benefited the most and recovered rapidly after the lifting of restrictions. In the second quarter, the YoY growth rate of catering industry revenue reached as high as 30% due to the low base last year. In contrast, according to our calculations, Meituan's YoY growth rate of food delivery orders in the second quarter was 29%, slightly lower than the industry average. It can be seen that although the overall prosperity of catering consumption is high, the offline recovery seems to have a more obvious crowding-out effect on food delivery.

Looking ahead, in the third quarter (as of August), the two-year compound growth rate of the catering industry reached 6.8%, which is a more significant increase compared to the 4.7% in the second quarter. However, according to company communication and some research, the growth of Meituan's food delivery orders in the third quarter may still be relatively weak, and the recovery of offline dining and tourism demand does not seem to be favorable for Meituan's core business of food delivery, but rather a negative factor.

3. Despite the downturn in the industry, the company's performance is not as bad

As can be seen from the data mentioned above, the growth rate of the online retail industry is undeniably slowing down. In recent months, the "billion subsidies," "good prices," and "sharpshooters" launched by Alibaba, JD.com, and Meituan have also been the focus of attention in the industry and by investors. However, the earnings reports of the major e-commerce companies (Alibaba, JD.com, Pinduoduo, Vipshop, and Meituan) covered by Dolphin Research in the second quarter presented a different picture.

Firstly, when excluding the impact of the fluctuation in the 2022 base year, the compound growth rate of these key e-commerce companies in terms of total revenue and core advertising revenue has increased in the second quarter compared to the first quarter. The growth rate has accelerated from over 8% in the first quarter to over 9% in the second quarter. This means that while the industry's overall growth rate (corresponding to GMV) has declined, the revenue growth of major e-commerce companies has improved.

In addition, the market was concerned that the various subsidies and promotions offered by Alibaba, JD.com, and Meituan would lead to intense price competition and a decline in industry-wide profits. However, the actual situation is that although the overall marketing expenses of these key e-commerce companies have increased year-on-year for the first time in four quarters (+1%), this is mainly due to the low base in the previous year's special circumstances. In terms of the proportion of marketing expenses to revenue, the second quarter's ratio of 8.4% is lower than the first quarter's 8.7%.

In terms of profitability, the overall operating profit margin of these key e-commerce companies in the second quarter has not deteriorated, but has significantly increased to 10.2%, even surpassing the pre-pandemic level of 2019.

Comparing the actual performance of the second quarter with expectations, it can be seen that the total revenue and core business revenue of companies such as Alibaba, JD.com, and Meituan have slightly exceeded expectations (although the lead is not significant). In terms of profitability, except for Vipshop, other companies have generally exceeded market expectations by 40%-60%, showing a significant outperformance.

Although the improvement in overall operating profit is mainly contributed by the reduction in losses from new businesses under each company, the performance of core business profits is mixed. However, at least it indicates that the profits of these e-commerce companies have not deteriorated as the market feared due to the competition that is more bark than bite.

In summary, under the explicit negative factors of industry growth slowdown and intensified competition, these companies have delivered performance results of revenue acceleration and profit improvement. The divergent trends between the industry and company performance are the most worthy of exploration and research in this quarterly analysis report. 2. Changes in the industry?

II. What has changed in past quarter?

In the previous section, we reviewed the performance of the industry and companies from the perspective of the rearview mirror, and found that although the industry performance was weak, the company's performance was not bad. So, what changes have there been in the company's actual operations and the competitive landscape of the industry in the past few months? Dolphin Research believes:

Internally, how did platforms achieve better-than-expected performance in monetization and profitability despite the industry downturn?

Externally, in terms of user and merchant operations, although mainstream e-commerce platforms have reached a consensus on prioritizing users and traffic, their strategies differ from Pinduoduo's focus on efficiency and monetization. Taotian and JD.com have chosen a "correct but difficult" path that may have short-term negative impact on platform profits but is effective in the long run.

1. E-commerce platforms still have room to improve "monetization rates"

1.1 In the second quarter, the year-on-year growth rate of China's online retail market was only 14% due to a low base, but Alibaba achieved double-digit growth in CMR revenue, JD.com's revenue guidance was zero growth, but the actual growth was close to 5%, and the e-commerce businesses of Douyin, Kuaishou, and Pinduoduo continued to grow at a rate of 30%-60%.

In other words, even under the premise of poor overall market growth, live-streaming e-commerce and these "new forces" such as Pinduoduo continue to outperform the market and seize market share, while Taotian and JD.com, who should have been "victims," have also achieved better-than-expected revenue growth. This creates an "impossible" scenario where it seems that all platforms are winners and there are no losers. This has puzzled Dolphin Research for a while.

However, when combined with Pinduoduo's astonishing revenue growth, the only explanation is an increase in monetization rates. Recently, Taotian also launched the "Wanxiangtai Unlimited Edition" advertising tool. Dolphin Research believes that the reason why the revenue of e-commerce companies in the second quarter generally exceeded expectations and the industry trend is that the monetization rates in the industry are generally increasing.

Taking Pinduoduo, which has the most significant changes, as an example, we estimate that the GMV growth rate of Pinduoduo's main platform in the second quarter was around 35%, but the advertising revenue growth rate was as high as 51%, indicating an increase in the monetization rate of the main platform by about 0.4-0.5 percentage points. The main driver behind this is Pinduoduo's "Global Promotion" advertising tool, which was launched in the middle of 2022.

Similar to "Wanxiangtai Unlimited Edition," "Global Promotion" is an all-in-one advertising tool that integrates various channels such as "search keywords," "fixed ad slots," and "information flow ads." Merchants can only set the advertising budget and the desired ROI target, while the specific advertising behavior is automatically completed by algorithms.

On one hand, Pinduoduo promotes "Global Promotion" and gradually shuts down the original separate advertising tools. On the other hand, it reduces the proportion of free traffic on the platform, thereby encouraging merchants to increase the usage rate of advertising tools and ultimately driving up the overall monetization rate.

Based on the same logic, although Taotian's "Wanxiangtai Unlimited Edition" officially aims to improve the efficiency and effectiveness of merchants' advertising placement, its essence is the platform's centralized allocation of traffic. There is also room and potential to increase the penetration rate and monetization rate of advertising tools in the future.

Since the first quarter, JD.com has been vigorously supporting the 3P ecosystem, and currently, the GMV share of 3P merchants has exceeded half. In recent communications, JD.com has also expressed its intention to encourage merchants to use advertising placement to drive growth. As the 3P ecosystem matures, improving monetization should be a natural progression.

In summary, after the domestic e-commerce platforms have reached the peak of GMV growth, there is a consensus to collectively improve the monetization rate. There is still room and methods to further enhance the platform's monetization rate, thereby offsetting the slowdown in industry-wide GMV growth to a certain extent. Therefore, we should not be overly pessimistic about the future revenue growth of pan-e-commerce companies.

1.2 Where does the confidence of the platforms to improve monetization come from in an industry that is not prosperous? In other words, why are merchants willing to give up more profit to the platforms? Dolphin Research believes that the reason is simple and concise - in the case of weak total demand in China, the power of demand (platforms with demand) is stronger than supply (merchants and products), and it is better to have thin profits and high sales than to have products "rotting" in warehouses.

First of all, as mentioned above, in the unfavorable macro environment, the growth rate of online retail is still outperforming the overall retail market. For merchants, compared horizontally, online channels can still provide better traffic and sales conversion rates.

In addition, under the resonance of weak domestic demand and weak overseas exports, domestic merchants face strong pressure to reduce inventory. Therefore, even if the platform increases its commission, merchants are willing to give up profit in exchange for sales volume.

Moreover, when all mainstream e-commerce platforms in China uniformly increase their monetization rates, online merchants actually have little bargaining power. Unless new traffic platforms emerge or a platform actively chooses to give up profit to seize the market, existing platforms do not have much concern about losing merchants.

In summary, in the context of overall low retail sales, the fundamental reason why e-commerce platforms have the ability to continue to increase their monetization rates is that online channels can still achieve relatively higher growth rates. (Of course, whether companies are willing to do so depends on their own goals and strategies)

2. Why hasn't profit been affected by intensified competition?

When JD.com and Taotian promoted activities such as "Billion Subsidies," the market was concerned about whether it would significantly impact platform profits. However, in reality, although the profits of Taotian and JD.com are not outstanding, they are not bad either.

The main reason is that the platforms do not rely mainly on their own subsidies, but on providing traffic tilt to small and medium-sized merchants at lower prices, thereby passing on most of the price costs to 3P merchants. According to expert research, the proportion of 3P merchants in the JD.com Billion Subsidies section is higher than the proportion of 3P merchants on the entire site, which also verifies the above logic. In addition, in the early stages of promoting "billion-yuan subsidies" by platforms like JD.com, the subsidy categories were mainly focused on high-value products such as home appliances, mobile phones, and digital products (such as Apple phones) to attract users' attention.

However, we have noticed that the proportion of daily necessities, food, and personal care products in the subsidy categories has significantly increased. This is more in line with the goal of promoting daily sales through "everyday low prices". In other words, the competition in subsequent categories of electrical appliances is relatively reduced, while daily consumer goods (which can drive daily active users) may be the most fiercely competitive category with the most damaged profit margins.

3. Competition in the foreground: User traffic/stickiness & pricing power

At the end of the first quarter, JD.com and Alibaba launched various "good price" and "subsidy" channels, which made us and the market concerned whether e-commerce companies would fall into the quagmire of "price wars".

However, after several months of analysis, we believe that e-commerce companies have reached a new consensus on their goals - that is, user traffic/stickiness is the most critical indicator, and GMV and revenue are the results that come with user stickiness.

However, in terms of implementation, JD.com and Pinduoduo have taken different paths:

a. Alibaba and JD.com have chosen to operate through a long-term approach of providing a good user experience and operating a merchant ecosystem, which is effective but slow.

b. Pinduoduo, on the other hand, tends to maximize the efficiency of the e-commerce platform as a shopping tool (reflected in low prices, conversion, monetization, etc.).

3.1 Pricing power, live streaming & short videos, "browsing" function, all for user traffic

First, from the perspective of pricing power, in the industry overview of the first quarter of this year, we pointed out that JD.com and Taobao's high-profile promotion of "billion-yuan subsidies" and other measures are not necessarily about competing with Pinduoduo in terms of absolute low prices. Apart from attracting attention, the fundamental purpose is to change consumers' habit of concentrated shopping during a few major promotions or holidays. The goal is to cultivate consumers' high-frequency and daily shopping habits on e-commerce platforms through "everyday low prices", ultimately increasing user traffic and usage frequency on the platform.

From the perspective of live streaming/short video content, Taobao has recently emphasized features such as "store integration", "Taobao Live", and "browsing" on its app interface. The ultimate goal is also to prolong consumers' stay on the platform. They don't want the platform to be just a shopping tool, but also to incorporate the functions of browsing, product recommendations, and even entertainment into the e-commerce platform, in order to increase user stickiness. Even though JD.com, which originally focused more on shopping channels, has relatively lacked in live streaming e-commerce and product recommendation features, it has recently highlighted the "JD Live" and "Explore" (short video product recommendation content) entrances on its homepage. This indicates that JD.com is also trying to enhance user stickiness and traffic through these additional features.

However, if we judge success or failure, although the goals and visions of Taobao and JD.com are "difficult but correct," and recent data from Questmobile also shows that the monthly active users of Taobao and JD.com have been increasing, while Pinduoduo's monthly active users have shown a significant decline from its peak.

However, in terms of the proportion of medium to high-frequency users who open the app more than once a day, the proportion of medium to high-frequency users on Taobao is less than 50%, while JD.com's proportion of medium to high-frequency users is less than 30%. At the peak, Pinduoduo's proportion of medium to high-frequency users was once above 60%.

Although the monthly active users and proportion of high-frequency users of Pinduoduo have declined recently due to the impact of the delisting of the Pinduoduo app from the Google Play Store, it can be seen that the proportion of highly sticky users on Pinduoduo is still the highest.

Therefore, in terms of the number of high-frequency users and user usage time, Pinduoduo is almost on par with Taobao in terms of GMV scale, while JD.com significantly lags behind. In other words, Taobao and JD.com still have a distance to catch up.

3.2 Taobao and JD.com choose "difficult but correct," while Pinduoduo chooses extreme efficiency

However, although the primary goal of the three leading e-commerce platforms (including Douyin and Kuaishou) has converged on the competition for user traffic, as mentioned in the previously released Alibaba Communication Memo, we believe that Pinduoduo tends to focus only on core functions and is satisfied with others being sufficient, emphasizing extreme efficiency. Taobao and JD.com, on the other hand, tend to provide as many services as possible to users and merchants, striving for perfection.

Similar to Pinduoduo's internal company culture of "60 points is enough, just get by," Pinduoduo focuses on how to provide consumers with the cheapest prices, how to sell the most products (hot-selling logic), and how to maximize its own monetization. It does not pay excessive attention to non-core functions such as merchant services, product recommendations, and even interface aesthetics (the interface of the Pinduoduo app is still quite simple to this day). On the one hand, providing users with a simple yet efficient shopping experience allows the company to streamline operations, save costs, and generate profits. On the other hand, platforms like Taobao and JD.com focus on providing users with more features (such as pre-sales recommendations, order fulfillment, and after-sales services) and better support for merchants (such as fair traffic distribution strategies to support small and medium-sized businesses, and AI tools for business operations).

However, the actual impact of providing these additional features on GMV and revenue is unknown, while the additional investments required by platforms or merchants are certain. Although these investments may be beneficial in the long run, they will inevitably affect the platform's (potential) profits in the short term.

For example, JD.com announced a reduction in the free shipping threshold from 99 to 59, and wireless free shipping for Plus members. While this move is expected to enhance the user experience and attract more users, Dolphin Research is skeptical about whether the additional fulfillment costs can be offset by the incremental users and GMV. In the short term, it is highly likely to drag down the company's profits.

III. Regarding the future prospects of e-commerce companies:

1. The domestic e-commerce business is unlikely to see much improvement. Looking at the industry growth rate, although September is expected to show improvement compared to August, the slowdown in online retail growth from July to August is an unchangeable fact. Therefore, the overall GMV growth rate of e-commerce companies in the third quarter is expected to continue to decline compared to the second quarter. However, due to the offsetting effect of improved monetization rates, the actual revenue growth will still be better than industry data.

In terms of profitability, although the overall profitability of the company, especially the reduction of losses in new businesses, will continue, the increased support for users and merchants by Taobao and JD.com will inevitably increase expenses. Moreover, they have chosen long-term operational strategies that may be beneficial but may not yield immediate results. Therefore, the profitability of the core e-commerce business of Taobao and JD.com is unlikely to bring any surprises.

As long as Pinduoduo can continue to improve the penetration rate and monetization rate of its advertising tools, its performance in the third quarter is expected to remain strong.

As for Meituan, although the demand for in-store tourism is expected to remain high in the third and fourth quarters, it is favorable for offline dining but unfavorable for Meituan's core food delivery business. According to recent communications from the company, the demand for local instant retail (including flash sales and grocery shopping) during summer vacations and holidays is not strong. The increased cost of cold chain delivery for grocery shopping and curated business due to the high summer temperatures will also lead to higher losses. Therefore, the outlook for the third quarter is not optimistic.

2. Overseas business may become a focus of attention. In contrast to the stagnant domestic e-commerce business, the development of our domestic e-commerce's overseas business is impressive. Specifically, Alibaba's international e-commerce group has achieved a revenue growth rate of up to 43%, with retail business growing at an even higher rate of 60%. Pinduoduo's Temu has even started to impact the performance of local discount retailers in the United States. Therefore, Dolphin Research believes that the overseas/cross-border e-commerce sector will become a focus of industry attention and potential investment opportunities. Dolphin Research will also release special reports on cross-border/overseas e-commerce in a timely manner, so stay tuned.

Related research by Longbridge Dolphin Research:

E-commerce industry

April 12, 2023: "Fierce competition in cost-effectiveness, when will Alibaba, JD.com, and Pinduoduo stop internal competition?"

January 5, 2023: "The tide has turned, Alibaba, Ctrip, Didi are ready to counterattack"

September 30, 2022: "Pinduoduo vs. Vipshop: Your 'hard times' are their 'good times'?"

September 22, 2022: "Alibaba, Meituan, JD.com, Pinduoduo: Have they all accepted their fate? Or are they still striving for success?"

April 27, 2022: "Alibaba vs. Pinduoduo: After the bloodbath, is coexistence the only option?"

April 22, 2022: "Meituan, JD.com, why are they performing well in the fierce competition for market share?"

April 13, 2022: "As the cycle declines, how much value is left for Alibaba and Tencent?"

Risk disclosure and statement for this article: Dolphin Research Disclaimer and General Disclosure