OREANDA-NEWS.  Fitch Ratings says that China's largest direct sales online retailer by revenue, JD.com, Inc. (JD) does not have an investment-grade credit profile due to its low profits and weak cash generation. In addition, Fitch believes that JD's internet financing business is an integral part of its retail operations and thus, the company needs to be analysed on a consolidated basis.

JD's profitability is weak, which Fitch believes reflects the competitive nature and high fixed-cost base of its business. Unlike Alibaba Group Holding Limited (Alibaba, A+/Stable), which mainly acts as a marketplace for third-party sellers, JD is a fully integrated online retailer, handling everything from merchandising to inventory management and fulfilment logistics. This model gives the company certain advantages, in particular a better customer experience, but is capital intensive and comes with a much higher cost structure.

As a result, the company reported EBITDA margin of only -0.2% to 0% over the past three years and Fitch calculates FFO margin to be 0.7% to 0.9%. Fitch believes there is potential for JD to improve these razor thin margins as it grows; however, so far this has not materialised despite revenue rising by CAGR of 72% over the past five years. In fact, fulfilment costs, the largest cost component after the cost of goods sold, rose to 7.7% of revenues in 2015 from 5.9% in 2013, despite revenue more than doubling during that period. Fitch believes that it is possible that margins may get worse before they get better as JD invests in its logistics network to cover lower-tier cities.

JD reported strong cash flow from operations (CFO) of CNY12.4bn in 2015 after excluding cash flows related to internet financing. The company provides financing to both its customers and suppliers. It uses its own financial resources and some additional equity funding, in addition to asset securitisation, to fund this portion of its business. Fitch believes that internet financing is an integral part of JD's core business of internet retailing as it boosts customer demand and helps the company get better pricing and terms from suppliers. Thus it is not analytically meaningful to consider CFO of the retailing business in isolation. The company's CFO on a consolidated basis was negative in 2015.

Furthermore, the company's negative CFO would have been worse if not for the fact that its retailing business operates with a negative working capital cycle: its payables term is far more generous than its receivables term. However, the growth of cash released from working capital will stabilise when the company's growth rate stabilises. Fitch believes it will be difficult for JD to continue expanding at well above market growth rates over the long term.

JD's credit profile is supported by its net cash position over the past five years, and its growth, which far exceeds the market average. Its focus on providing a better customer experience compared with other internet retailers will continue to serve it well. However, Fitch believes that an investment-grade profile would require stronger and more sustained profit margins and positive consolidated CFO.