Vipshop Cultivates Its VIPs at Expense of Broader Growth

The discount e-commerce company’s profit grew strongly in the third quarter, but that came on cost controls, as its revenue fell 13%

Key Takeaways:

• Vipshop’s non-GAAP profit rose more than 50% in the third quarter, but its top line revenue declined by 13%
• The company emphasized it will stick to its current cost control approach and continue to focus on profitability

By Trevor Mo

“Making profits in China’s competitive e-commerce market is tough, especially in the current environment. But we can not only do it, but do it better than the competition.”

That was the pitch coming from Vipshop Holdings Ltd. (VIPS.US) in its investor call following the release of its latest quarterly earnings last week. The online discount e-commerce specialist, known for reporting a profit for every quarter since 2013, kept its streak alive with another report showing its net profit grew 55% in the third quarter.

Investors liked what they saw, bidding up the company’s shares by 8% in the three trading days after the earnings came out, including a 3.6% rise the day of release last Tuesday.

That put the company’s shares up for the year by 15% – something most China internet stocks can’t say these days. By comparison, shares of more mainstream e-commerce rivals Alibaba (BABA.US; 9988.HK) and JD.com (JD.US; 9618.HK) are down more than 25% year to date, though rival discounter Pinduoduo (PDD.US) is up by a similar amount to Vipshop.

That appears to show the discounters are in vogue right now, which should come as no surprise since they are positioned to perform relatively better as consumers rein in their spending and look for more bargains in the current sluggish economy.

Despite its relatively strong performance, Vipshop currently trades at a forward price-to-earnings (P/E) ratio of just 6, compared with a similarly anemic, but still higher, 9.8 for Alibaba. Global peer Amazon (AMZN.US) trades at a much higher forward P/E of 46, which used to be the norm for such high-growth companies. But then again, none of the Chinese e-commerce companies looks very high-growth these days, with most reporting revenue gains of 10% or less, or even declines.

Vipshop was among that crowd, reporting a 13% revenue decline in its latest quarter. Still, it achieved strong profit growth by adopting aggressive cost control measures. While that’s an effective strategy to weather lingering macro headwinds, it could also mean the company’s earlier days of strong growth may be in the rear-view mirror for the time being.

We’ll delve into the details of Vipshop’s latest quarterly financial report shortly, which can be best summed up as a “mixed bag” of strong profit growth tempered by shrinking revenues. We’ll also review some of the company’s latest initiatives to jumpstart growth.

But before that, we’ll review the company’s history, including its very value-oriented proposition that helped it carved out a space in China’s ultra-competitive e-commerce landscape.

Vipshop has focused on the discount market since its founding in 2008, where it buys excess inventory from major brands at low prices and sells it at a discount, similar to the traditional “outlets” business model. After finding quick success with that model, the company listed in the U.S. just four years after its inception. A large number of imitators have sprung up over the years since then, including names such as Fclub, Jumei, Mogujie and Juanpi. But most of those have either vanished or are struggling now.

Cost control mode

With all that background in mind, we’ll spend the rest of this space taking a deeper dive into Vipshop’s latest earnings, starting with an impressive 55% rise in its non-GAAP net profit, which excludes share-based compensation and other expenses, to 1.6 billion yuan ($223 million) during the third quarter. That strong performance was probably the main driver behind the stock’s gains after the announcement.

But the strong net profit growth came on heavy cost cutting rather than revenue growth, in line with the company’s aggressive strategy implemented since at least late last year. Notably, its marketing expenses were down 54% year-on-year to 572.4 million yuan, equal to 2.6% of total revenue, versus 5% in the prior year.

As it slashed its marketing spending, Vipshop’s third quarter revenue dropped by 13% to 21.6 billion yuan. It forecast revenue would continue to fall in the fourth quarter, though it said the decline would moderate to between 5% and 10%. Management didn’t comment on the company’s performance during the recent “Single’s Day” shopping extravaganza on Nov. 11, similar to the lack of specific sales data from most e-commerce companies. That has led many to suspect that sales were flat for most companies or even fell for the first time since the event’s inception.  

On the call, Vipshop management blamed the sluggishness on “soft consumer needs for discretionary categories amid a challenging macro environment with the Covid-19 resurgence in China.” Scaled back marketing spending also led the company to post a net outflow of users on its platform, with the number of active customers dropping 6.6% year-on-year and 1.7% quarter-on-quarter to 41 million.

For some analysts covering Vipshop, declining user numbers is a worrying sign. “It is important for Vipshop to increase its marketing spending and, thus, grow its user base to boost its top-line growth,” China Renaissance said in a research note.

Managers said they expect the rate of user declines to narrow in the first half of next year. But they emphasized profitability will be their continued focus, and ruled out any possibility of a pivot from the current cost-control approach anytime soon.

Instead of spending heavily to acquire more users, Vipshop will continue a strategy of seeking to milk more money from existing ones by turning them into “super VIP” members. Such users enjoy benefits such as free return shipping with an annual payment, and the company said they usually spend more on its platform. For the third quarter, those users grew by 21% and contributed 40% of the company’s online net gross merchandise volume (GMV), according to Chairman and CEO Shen Ya, who also uses the English name Eric.

As part of its more modest growth strategy, the company is also seeking to diversify its product offerings, which are currently focused on apparel and related products. Other categories Vipshop is pursing include cosmetics, electronics and children’s goods, though it didn’t provide specific data on those categories in its latest results.

Its third quarter results show the company is able to operate profitably, but investors might also want to see if the company can achieve that by actually growing its business instead of resorting to aggressive cost controls. 

As to how long investors might need to wait before Vipshop can return to revenue growth, it will depend on the effectiveness of many of its latest initiatives. But more important is how the Covid pandemic situation develops in China, where frequent lockdowns and other control measures have wreaked havoc on logistics services and dampened consumer demand.

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