Monday, August 26, 2019 7.00PM / Teslim
Shitta-Bey, Managing Editor/Image Credit: Jumia
With its Q2 2019 Results the subject of critical analysis after harsh commentaries by an American short seller in Q1 2019, Jumia is finding itself again in the crosshairs of analysts who have expressed concern over its rising operating loss which rose from Euro 41.9m in Q2 2018 to Euro 66.7m in Q2 2019. The 59.2% rise in operating loss appears to underscore the 'short' (sell) position of some investors a few weeks after the stock was listed on the New York Stock Exchange (NYSE) when the stock lost 48.8% in market value over a two week period. Most of the lost value occurred in the three days after its conference call meeting with analysts on May 16 2019 and the release of a damning report by Citron, a research and short sell specialist firm in the United States of America (Read Proshare's report, JUMIA's IPO and Q1 2019 Result; Understanding The Numbers and Ignoring the 'Noise').
Are the concerns genuine? A lot depends on the type of investor doing the analysis. From its prospectus on the NYSE in 2019 and its earlier investment memorandum in 2018, the company's managers were clear about the fact that the company would be making operating losses for a number of years, the expected breakeven point on operational profit was set at 2022. But this is not unusual for companies in the online retail sales business. A lot of the operating success of an online retail platform is tied to the volume of transactions done on the platform and the number of active buyers. The more the number of active buyers on the platform the higher the top line revenue as represented by gross merchandise value (GMV) and the stronger the company's bottom line (as represented by earnings before interest, tax, depreciation and amortization or EBITDA).
Jumia's active customers differ from total site visitors or users. Typically an active customer is a visitor who has made a paid purchase over a period of a year. The companyâ€™s active customers rose from 3.2m in Q2 2018 to 4.8m or a growth of 50%, this is a critical ratio in forecasting forward bottom and top line earnings. To grow the numbers the company has entered into a service level agreement (SLA) with Nigeria Postal Services (NIPOST) to improve logistic support across the country while also using smaller logistic companies in areas where they have obvious service delivery advantages, particularly in rural communities. If the gambit works properly Jumia should be able to push up active customers to an additional 400,000 customers by year end 2019, bringing active customer base to at least 5.2m.
Jumia's active customer base is less than 5% of the country's total population of about 200m and is only about 9% of the country's adult population. This is both a problem and an opportunity. The low base of active customers suggest a relatively low top line earnings, but it also shows the potential for a fast ramping up of income if the company can onboard more paying customers. The company's recent market place revenue rose from Euro 9.2m in Q2 2018 to Euro 17.5m in Q2 2019 representing a year-on-year (Y-o-Y) growth of 90.2%.
A Further Look At The Numbers
The unique revenue structure of the online business of digital retail platforms means that the interpretation of their operating performance differ from manufacturing companies like PZ, Guinness or Dangote Cement. Whilst line item like Gross Revenue is a critical performance driver of a manufacturing company's profit and loss account, for a digital retail platform the top line consideration would be its Gross Merchandise Value (GMV) which is somewhat different from its Gross Revenue. The gross revenue of a company like Jumia reflects not the revenue from the total sales made on its platform but the proportion of those sales that can be considered as Jumiaâ€™s income (this is usually the negotiated discount multiplied by the volume of sales of items on the platform).
While Jumia's GMV rose 69% Y-o-Y its Gross Profit figure rose even better by 94%. Critical to its battle for market traction the company has pursued a strong service monetization strategy; this has meant that over the last twelve months Jumia has squeezed additional revenue from its fulfillment cost obligations (represented by a savings on its logistics expenses), increased its marketing and advertising revenue (which grew by 490% between Q2 2018 and Q2 2019) representing 8% of market place revenue in Q2 2019 as compared to 2% of market place revenue in Q2 2018.
Topline numbers of the company look bright, but bottom line figures are sadly a different tale. The company clearly needs to grow faster topline earning numbers while keeping a chokehold over fulfillment costs and S&A expenses; hammering down costs appear to be the only way to guarantee business sustainability. But in doing this, the company needs to equally improve consumer service experience which still falls short of best global practice.
The Cost Conundrum
Jumia's Achilles heel is its biting operating cost which swallows revenues like a whale feeding off plankton. Its profit and loss account looks fairly impressive until analysts get to the point of costs where deductions for expenses on Fulfillment and Sales and Administrative (S&A) expenses punch gaping holes into an otherwise strong revenue template. This being said, Jumia's Fulfillment and S&A as a proportion of GMV fell by 76 basis points from 6.2% in Q2 2018 to 5.4% in Q2 2019. The company's EBITDA loss as a proportion of GMV equally improved from a negative of -21.4% in Q2 2018 to -15.8% in Q2 2019, this obviously was as a result of the +90% leap in the digital platforms GMV over the period.
The company's fulfillment expense jumped from Euro 10.3m in Q2 2018 to Euro 17.6m in Q2 2019, representing a 69.8% rise (which was actually lower than the Y-o-Y rise in GMV). As a percent of GMV, Jumia's fulfillment cost actually went up from 6.2% in Q2 2018 to 6.3% in Q2 2019, suggesting increasing cost pressure in the delivery of goods to customers. A further downward pull on Jumia's earnings was the rise in its sales and administrative cost(S&A) which climbed from Euro 10.3m in Q2 2018 to Euro 15.3m in Q2 2019, representing a rise of +48.3%. Indeed, growth in the company's merchandise volume has meant a rise in its administrative and sales costs, which is a sore point for Jumiaâ€™s chosen business model. If the model is to work and the company is to achieve its 2022 Group operational breakeven target, the management must come to terms with the need to reduce the growth of logistic expenses and dramatically slow the growth of G&A costs.
General and Administrative expenses (G&A)are just as much a nightmare as the S&A costs as they grew by +83.5% between Q2 2018 and Q2 2019, from Euro 24.5m in Q2 2018 to â‚¬ 41.9m in Q2 2019 (see Table 1 below).
Table 1 Jumia: General and Administrative Expenses Q2 2018 and 2019
Source: Jumia Q2 2019 Press Release
Much Ado About Fraud
Social media has been agog with allegations of 'fraud' going on in the company especially as it relates to activities of the company's sales agents. The issue borders on what accountants call 'materiality' or the relative size of the problem. The company's Nigerian managers on enquiry have said that the problem affects only about one percent of its revenues and perhaps less than 5% of its active sales agents of 10,000 domestic operatives in Nigeria. So far no clear evidence of outright fraud on the part of management has been established and no staff, according to the company's management, has taken it to court over dismal for issues of poor conduct such as some instances of collusion with agents to rig the commission system. The matter of loose internal management controls and corruption may require either added investigation or more time to confirm purported allegations.
But a problem rankling investors is the $17.5m fraud committed by staffs of the company who were alleged to have overstated the size of platform's marketplace orders made by customers, thereby ballooning the company's GMV and its agentâ€™s commissions.
The 2022 Race and The 'J' Strategy
Jumia's management insists that it is prepared to achieve a breakeven operating profit by 2022 and to do this it has identified four handle bars of strategy which include, but are not limited to the following:
The management has started the process of pushing for faster-paced growth of GMV as evidenced by the Q2 result and its strategic alignment with NIPOST and other local logistic companies. To support higher 'fans-to-customers' conversion volumes, the company has increased revenue streams from marketing and advertising thereby raising its monetization. Both approaches to revenue increase emphasize a generic approach to strategy by attempting to increase market share through growing traded consumer volumes. The cost efficiency imperative of Jumia's strategy is also part of a generic approach to business sustainability. Containing escalation in logistics costs should reduce fulfillment deductions and improve EBITDA. But the hike in logistic cost is something that the company has to handle carefully as service provider power is particularly strong in the sector, in the Harvard University Professor Michael Porter context of supplier power in his classic five forces of competition model.
To increase monetization the company has pushed for more revenue flows from advertising and marketing by third parties and by cut-backs to fulfillment costs. A reduction of fulfillment costs will gradually see bottom line earnings float up as this P&L item has been a major recent deduction resulting in a Q2 operating loss of Euro 66.7m (as against Euro 41.9m in Q2 2018).
Jumping on the Fintech bandwagon should help drive monetization, but a lot will depend on Jumia's ability to manage credit creation on the platform while complying with the lending rules of the Central Bank of Nigeria (CBN). Jumia would also need to obtain a payment solution license and work within the parameters established for such financial service. The JumiaPay solution is a sensible service extension but its success will still depend majorly on the ecommerce platform's onboarding of a growing number of active customers.
Illustration 1 Jumia's Four Bar Strategy 2019-2022
The Investor's Dilemma
A tribe of analysts have, understandably, turned their noses up at the prospect of buying into Jumia, they have said that the company's negative operating profit and the allegedly unclear and weak internal control procedures make the stock a doubtful proposition. On the face of it, this line of argument appears sound. An operating loss of Euro 66.7m in Q2 2019 up from Euro 44.1m in Q2 2018 is not anything to smile about. Nevertheless, extenuating circumstances may still redeem Jumia's image as a growth stock. The company's share price has collapsed by 73.9% since its highest value of $46.99 per share in May 2019 as its price dropped to a recent $12.77 per share on Friday August 23, 2019 (see chart 1 below). The decline in equity value has so far hurt investor portfolios and built lower price resistance.
Chart 1 Jumia Share Price and Volume Movement July-August 2019
Source: NYSE, Proshare research
On the New York Stock Exchange (NYSE) over the last two months Jumia has traded along a bearish tunnel with its share price tumbling by 18.1% on a compound weekly basis. 'Income' investors will certainly run scared of the stock's laggard performance but 'value' investors may take a slight pause. Jumia's topline activities have been decent over Q2 2019 with the exception of operating losses that headed in the wrong direction, this is a problem that can be fixed, but the company's management needs to climb on top of its rising expenses and rein in operating costs as quickly as possible.
Jumia's management must also strengthen internal oversight and review its operating processes to block out internal abuse. The company also needs to bring down order cancellations, returned goods and refunds. The exact figures for refunds and cancellations have not been revealed by the company but it is obvious that the line item is a major sore point in its translation of site visits to consummated transactions.
Despite, the obvious brilliance of the chief executive of Jumia Nigeria, Juliet Anammah, the company has to tighten up and follow through on its four handle bar strategy over the next few months. Analyst's negative views of the company will not change any time soon if Q3 and FY 2019 results do not stir optimism in closing down fulfillment and G&A costs and improving the ratio of GMV to active customers and the ratio of GMV to fulfillment expenses. Africa's premier ecommerce platform may have great opportunities but opportunities are as good as dreams; they require strategic action to bring them to reality.
As at the time of this report the management of Jumia had yet to respond to Proshare's enquiries concerning the alleged legal cases that may in future have material impact on the company's future bottom line and issues related to the equally speculated weakness of internal control processes that enabled staffs and agents of the company conspire to inflate the Groupâ€™s gross merchandise value (GMV).
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