Dada Nexus

Significant operating leverage about to kick in

Well busy week, I did more digging on Dada Nexus (DADA) (previously mentioned here when it was trading just under $1.7 and closed here at $2.6). The company owns Dada Now, a crowd sourced last mile delivery service and JD Daojia or JDDJ, an on demand retail platform with over 200k stores and brand owners that also provides other functions such as online delivery inventory look-up for store employees, crm services such as membership passes etc. 

Dada Now makes up about 36% of revenue with JDDJ the rest. Dada Now was growing faster in 2023 at a 30% rate in Q3 vs JDDJ which grew at 15% (and I think JDDJ had its revenue overstated, so it is probably even a bit lower).

Some facts about this stock: 

• JD owns ~54% of DADA and Walmart ~9%.

• A group of lower level managers had overstated both costs and revenue at the same time. JD appointed a new chairman and CFO at the end of 2023 (JD logistics veterans) and an independent review was started which has recently concluded that both revenue and costs the first 9 months of 2023 were overstated by about 500 million RMB. Or about $70 million. No other irregularities were discovered.

• Market cap is just over $600 million and net cash is roughly $500 million.

• 2023 revenue will likely come in at $1.55 billion. 

• Stock trades at ~1x Gross profit.

• Operating costs are pretty much fixed since 2021 despite 50% revenue growth, so lot’s of potential for operating leverage to kick in with further revenue growth.

• Break even point seems to be at the $1.7 billion revenue mark. 

• Analyst consensus for 2024 revenue is about $1.85 billion according to TIKR. 

• Decent moat coming from the network effect and economies of scale. Business is also fairly capital light.

I was going to write a more in depth report, but then I found this detailed write-up by Pyramids and Pagodas from December last year. So I will provide more of a summary and focus on some points not mentioned in that write-up. 

To summarise why this stock piqued my interest, there is still a significant growth runway, with significant operating leverage. If revenue were to reach say $2.5 billion in 3-4 years, the company could generate close to $200 million in FCF. On a $600m market cap. Without having to make aggressive assumptions about net profit margins. And the net cash position would soften the blow if the company fails to execute.

I think perception around this stock is too negative due to recent fraud discoveries (which had no real negative impact on profitability), JD losing share and just general negative China sentiment. 

There is potential for further consolidation and to further monetize JD’s user base (only 14% monetized so far). Risks are that JD is losing market share to Pinduoduo (but their revenue is still expected to grow, just at a slower pace). But even if JD’s revenue would flat line, a penetration of 50% of JD’s user base (which management thinks is doable in the long run) could still provide a significant growth runway for DADA.

Potential catalysts are:

• The company showing further growth which will likely result in generating positive FCF.

• Capital returns in the form of buybacks or dividends. From JD’s perspective buybacks make so much sense here, they can increase their ownership at an incredibly cheap price and DADA has way too much excess cash.

• A buyout announced at some point by JD.

This is a stock that IPOed at $16, now trades at $2.35, has an enterprise value of only $0.40/share, has a sizable moat, has one of the largest e-commerce companies in China (JD) as a >50% shareholder and supporter, provides an essential service (so no risk of this being a fad) and could potentially become very profitable in the medium term.

You have to skate where the puck is going to see value in this stock. So let’s have a look at the numbers. TIKR analyst estimates and actual results so far in USD$:

It looks a bit messy, but my estimate, assuming Gross margins at 39% and Opex stays fixed and adding back most of the D&A expense (as most of it is amortisation of the business cooperation agreement with JD) I get about $50m of FCF for 2024 and $100m for 2025 if opex grows by $50m. That is with the above revenue estimates. 

What about the risks? Well this is still a Chinese company of course, and DADA has never generated a profit. They are not the largest player. If growth stalls and they keep burning cash, there is further downside here towards the ~$1-2 range. And of course there is a small risk that further accounting irregularities are discovered. Although I think this is rather unlikely at this point.

Another thing I don’t like is the VIE structure (this is mandatory due to Chinese regulations with regard to foreign investment in e-commerce businesses). The vast majority of DADA’s revenue and cash is directly owned, but DADA’s business licences are stored in a VIE (source company 20-F):

If you don’t know what VIE’s are, here is a primer. For some people this would be a deal breaker, but I can live with it, given the cheap valuation.

Not much revenue growth is needed here for this to work out rather well and there are plenty of potential catalysts so I entered back into a medium sized position in DADA shares at a price of $2.35/share. 

The company reports Q4 results Monday on the 25th after market close. Fingers crossed that they will announce a buyback.

Besides DADA, my current basket of US traded China stocks with possible catalysts next week looks as follows now:

• Greentree Hotels (GHG). Competitor HTHT just reported better than expected results. The bet here is that GHG has positive catalysts in the form of a dividend resumption (hopefully announced next week in their earnings report), a buyout (controlling shareholder owns 90% of shares outstanding) and further revenue/earnings growth. It trades at an undemanding 5-7x earnings (depending on where results come in). Fairly illiquid though, so beware. Will report March 25th after market close. 

• Noah Holdings (NOAH). Wealth management business with $800m in net cash and investments and a $690m market cap trading at a single digit PE ratio. Catalysts will be resumption of revenue and profit growth and capital returns likely announced at the coming earnings release next week.

  Main risk here is that they possibly generate a sizable portion of their income from Chinese capital flight. A portion of their business sits in VIEs. They have about $450m of cash and another $150m in longer term investments sitting outside their VIEs available for distribution. I am keeping this on one on the smaller side due to the VIEs. Will report March 26th after market close.

• Douyu (DOYU). Near identical to HUYA yet trades at a large discount due to the CEO being arrested on illegal gambling charges. And at about a 75% discount to net cash and investments. HUYA recently announced a large dividend, if DOYU pays out a similar % of their net cash in a special dividend, that would be about ⅔ of their current share price. As a reminder, both have Tencent as a major shareholder, both compete in the streaming business and both are sitting on a huge net cash pile. Risks are no capital returns, their business seems to be in terminal decline and potential for a large fine, beyond all the obvious “this is China” risks of course. Will report March 26th before the market opens.

Let’s see if I can keep up my (mostly) winning gambling streak on Chinese stocks so far :). *knock on wood, fingers crossed, frantically air drawing shapes of the number 8*.

Readers of this blog should do their own due diligence before buying or selling anything, since I have been wrong before and cannot guarantee all information in this write-up is 100% factual. I may buy or sell the above mentioned stocks at any time. I am not your financial advisor. Past success is no guarantee for future success.