S&P Assigns 'BBB-' Rating to JD.com (JD); Outlook Stable

Standard & Poor's Rating Services said that it had assigned its 'BBB-' long-term corporate credit rating to the JD.com Inc. (Nasdaq: JD). The outlook is stable. At the same time, we assigned our 'cnA-' long-term Greater China regional scale rating to JD.

We also assigned our 'BBB-' long-term issue rating and 'cnA-' Greater China regional scale rating to the company's proposed issuance of U.S. dollar-denominated senior unsecured notes. The rating on the notes is subject to our review of the final issuance documentation.

"The rating on JD reflects our view of the company's satisfactory market position as the largest online direct sales retailer in China, supported by an improving product and service offering and a highly scalable technology platform," said Standard & Poor's credit analyst Shalynn Teo. "JD's participation in China's highly fragmented and competitive retail industry and its low profitability temper these strengths."

In our view, support for the rating comes from JD's satisfactory brand recognition, technology capabilities, and market positioning, with a focus on product quality, service, and delivery. The company had a growing market share of 56.9% in terms of gross merchandise value (GMV) based on online direct sales for the third quarter of 2015, compared with 36.8% in 2011. JD continues to expand its product offering through direct sales and the marketplace to provide a one-stop platform for its customers, further driving higher customer traffic and growth.

In addition, we believe JD's nationwide logistics network with its in-house last-mile delivery gives the company a differentiating edge. The company can better manage its delivery process and enhance the customer experience. However, the higher expenses incurred and capital expenditure required to meet these investments could weigh on the company's financial position.

The rating also reflects JD's smaller scale than that of global retail peers and e-commerce providers. Nevertheless, we expect the company to benefit from positive industry fundamentals in China, including increasing penetration of online retailing. JD has an exclusive strategic partnership with Tencent Holdings Ltd. (A/Stable/--; cnAA+/--), its single largest shareholder with a 4.2% voting power. The partnership should allow JD to extend its mobile penetration as it will be able to build on Tencent's large social user traffic in China. Overall, we view the company's business risk profile as fair.

In our view, JD's profitability is weak, due to the highly fragmented and competitive operating environment. The company competes with e-commerce providers, more specialized online retailers, and offline retailers including department stores, specialized retailers, and shopping malls. However, we expect EBITDA margins to remain marginally positive at 1.0%-1.5% (excluding captive finance) over the next 12-24 months from about 1.0% in 2015, driven by increasing diversification into higher-margin businesses, including category expansion within its direct sales business and growth in marketplace operations, which is offset by rising fulfilment and marketing expenses.

We deconsolidate the financial contribution from JD's captive finance operations when assessing the company's financial risk metrics. We expect JD to maintain a net cash balance over the next 12-24 months, supporting its financial risk profile. We also expect JD to generate positive free operating cash flows over the next 24 months due to improving working capital management and profitability, which should offset capital expenditure needs.

We expect the expansion of JD's capital finance operations to support the growth of its Internet financing business, which should allow the company to attract user traffic and further increase sales. However, the increased scale in Internet financing, which will be largely debt-funded, will weigh on JD's overall financial position, with its high leverage position. As a result, we assess JD's overall financial risk profile, when taking its captive finance business into account, to be modest. JD's captive finance segment has no further impact on the rating because we believe that it does not introduce further risks such as borrower concentration, currency, or asset and liability mismatches.

JD is exposed to regulatory risks in relation to its variable interest entity (VIE) structure (a corporate structure that allows foreign investors to control domestic assets when direct ownership is not allowed by regulations). Given Internet content provider licenses, domain names, and some trademarks are owned by these VIEs, the company's business operations could be severely affected if the government disallows such VIEs in China. However, we believe the risks for JD are limited, given that it derives the majority of its revenues from wholly owned foreign entities, and only a limited portion of its assets and cash are at the VIEs. In our view, these risks are further mitigated by ongoing regulatory reviews. We believe JD's merchandise sales and logistics operations are less politically sensitive and less likely to be included in the "negative list" imposed by the Chinese government in the future. In addition, we consider JD to have better growth prospects in China than its rated peers globally, and an improving scale and profitability despite the intense market environment.

"The stable outlook on JD reflects our expectation that the company will maintain its good business growth and improve its margins over the next 12-24 months, despite intense market competition," said Ms. Teo. "We expect JD to maintain a new cash balance over the period, commensurate with its financial risk profile. In addition, we expect the company to continue to implement strict underwriting standards and satisfactory delinquency ratios for its captive finance operations."

We could lower the rating if JD's operating performance deteriorates significantly, such that that debt-to-EBITDA ratio exceeds 1.5x without signs of improvement. This could happen if: (1) JD undertakes more aggressive acquisitions or capital expenditure than we expect; or (2) the company has difficulty executing its expansion strategy or faces more severe competition than we expect, resulting in a deterioration in its profitability. We could also downgrade JD if the company fails to generate positive free operating cash flows as of 24 months from now.

We could also lower the rating if the regulatory risk relating to the company's VIE structure substantially increases due to a change of the Chinese government's policy toward foreign ownership, or the company's governance favors the interest of management over those of other stakeholders.

We could raise the rating if JD materially enhances its competitive position and profitability, driven by better product diversity and stronger market position, while maintaining minimal leverage.

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