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Trade war is turning China's local manufacturers to the domestic market, says e-commerce giant JD.com

Key Points
  • Chinese e-commerce company JD.com reports second-quarter revenue that beat market expectations and a net profit, following a loss in the same period last year.
  • "Given perhaps the trade tension, more and more manufacturers will actually turn their attention to (the) domestic market," Sidney Huang, chief financial officer of JD.com, tells CNBC.
  • "We think it's a good opportunity for us to reach down to those quality manufacturers, so we can provide those products at a really good value to our consumers," he says.
Several boxes of goods, bought from JD.com, are stacked on the floor.
Zhang Peng | LightRocket | Getty Images

BEIJING — Chinese e-commerce giant JD.com sees a business opportunity in factories that have been affected by trade tensions between the world's two largest economies, the company's chief financial officer told CNBC on Wednesday.

As JD.com seeks to tap the growth potential of China's smaller cities, the pressure is on to undercut competitors on price and quality. Meanwhile, Chinese manufacturers are finding it more expensive to sell to the U.S. given tariffs imposed on billions of dollars' worth of goods. Chinese exports to the U.S. have fallen for eight straight months, according to China Customs data from Wind Information.

"Given perhaps the trade tension, more and more manufacturers will actually turn their attention to (the) domestic market," said Sidney Huang, JD.com's chief financial officer. 

"This is a phenomena actually already happening for quite some time, slowly, that there are excess capacities for those manufacturing facilities," Huang said. "So there are a lot of very, very low-priced products at good quality they used to produce (as) branded products for global brands. So we think it's a good opportunity for us to reach down to those quality manufacturers, so we can provide those products at a really good value to our consumers."

JD.com's shares surged nearly 13% in New York trading overnight after the company delivered second quarter numbers showing exactly what the market wanted — profitability.

On Tuesday, the Chinese e-commerce giant reported these results for the June quarter:

  • Net revenue of 150.3 billion yuan ($21.9 billion), a 22.9% year-on-year rise
  • Net income attributable to ordinary shareholders of 618.8 million yuan ($90.1 million), compared to a net loss in the same period last year.

Importantly, JD.com's margin ticked up sharply and management raised adjusted net income guidance to between 8 billion yuan and 9.6 billion yuan for the full year. JD has reported full year losses for the past three years. That improving profitability picture helped propelled shares higher in U.S. trade on Tuesday, with the company adding about $5 billion to its market capitalization.

"The street didn't expect them to do well on the bottom line ... this is not (just) going to be the first time, it's going to be the beginning of a new trend," Tian Hou, founder and CEO of T.H. Capital, told CNBC's "Street Signs" on Wednesday.

For CFO Huang, the latest results indicate that the company's spending on warehouses, delivery people and other investments are beginning to pay off. He pointed out that fulfillment expenses as a percentage of net revenues decreased to 6.1% in the second quarter, the lowest since the company went public in 2014. The IPO was the last time Huang spoke with the media before sitting down on Wednesday with CNBC, he said.

Fulfillment costs overall did rise, even if the ratio fell. But the company also revealed Tuesday that its logistics business broke even from an operating income perspective.

"We are seeing operating leverage," Huang said, noting that July sales numbers are pretty robust. 

Shares of JD are up over 46% year-to-date versus just under 20% for rival Alibaba, which operates the popular Taobao and Tmall online shopping platforms in China.

JD's business model looks a lot more like Amazon than Alibaba, however. It owns more of the inventory it sells in addition to operating a marketplace. Alibaba platforms, meanwhile, are more marketplace models.

"Profits in the long-run will continue to grow," Richard Liu, CEO of JD.com, said on an earnings call on Tuesday, of the entire JD.com business.

Investment in smaller cities

Liu said the company would look to invest more heavily in growing in smaller Chinese cities. Its growing logistics network could help it serve that market, according to Hou.

"I think the logistics is actually JD's strength. And logistics of JD can actually reach out to the really lower-tier cities … if you can reach out to the really sixth-tier cities … because of the difficulty of developing, that is your moat, your strength," she said.

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Lower-tier cities have become something of a battleground for Chinese e-commerce players Alibaba and newer rival Pinduoduo (PDD). Such cities often feature less infrastructure and consumers that are more price sensitive. Pinduoduo, through its mobile-focused social shopping product offering heavy discounts, has made some headway there. That's where JD could face some stiff competition as it looks to expand, although Huang said that when it comes to product value, Pinduoduo operates in a much lower segment of the market than JD.com does.

James Lee, U.S. and China internet analyst at Mizuho Americas, has kept a neutral rating on JD's stock despite raising the price target, saying the company needs to do more to win in lower-tier cities.

"We want to see the company be more aggressive in tier-three and tier-four markets, PDD is super aggressive in those markets, and what we want, would like JD to do is more heavily market in those markets ... by giving deeper discount ... to attract those consumer in order to win the market share. We haven't seen that yet," Lee told CNBC's "Street Signs."

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