Should Investors Put Dingdong and Missfresh on Their Watch Lists?

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In this episode of Industry Focus: Consumer Goods, join Motley Fool host Emily Flippen and analyst Asit Sharma as they take a big bite out of the Chinese grocery-delivery market and break down two recent F-1 filings — Dingdong and Missfresh. 

To catch full episodes of all The Motley Fool’s free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on June 15, 2021.

Emily Flippen: Welcome to Industry Focus. Today is Tuesday, June 15th, and I’m your host, Emily Flippen. Today, I’m joined by Motley Fool Senior Analyst Asit Sharma, as we take a look at the Chinese grocery delivery market and the two competitors that recently filed for IPOs in the U.S., Dingdong Maicai and Missfresh. Asit, thanks for joining.

Asit Sharma: Emily, thank you for having me and man, just from the names of these two IPOs, this is worth the time we put in for the research.

Flippen: I know that I’ve been removed from China too long because both of these names did give me chuckle, but I was also not familiar with either of them. I left China in 2017 and both of these companies have scaled up just since 2017. They weren’t even around last time I was there, which is a real testament to how quickly, I think, the Chinese market develops.

Sharma: That’s true. It’s like a blink of progress, there are so many fronts that have been following, or dabbling a little bit in their bullet train industry, just I’m always over audit how fast things move in China. But having said that, how does a really good infrastructure idea or a consumer-facing app or business turned into a good investment? That’s not always the easy part.

Flippen: What I will say about both of these businesses, if we’re going to talk about both of them, but we’re going to spend more time talking about Dingdong. Because as I was doing research into these businesses, I found, at least in my opinion, that comparing Dingdong to Missfresh was like comparing Chipotle to those taquitos that you can get at a convenient store. It was night and day between these businesses. I was personally way more excited about the former. That’s why I really centralized a lot of my research. I’ll lightly touch on the end about why Missfresh just doesn’t excite me.

Sharma: Well, I want to say on behalf of Missfresh, ouch. Probably deserves it. I think I have a few more comments about Missfresh to mix in, but I don’t think my opinion is too much different after studying up on these two companies.

Flippen: Well, Dingdong’s a really interesting one. Again, I mentioned that this was a business that started operations around Shanghai in 2017, that was about the same exact time that I was leaving the country. But my familiarity with Dingdong actually goes back a little bit further. This was a business that was in existence all the way back in 2014, about the time I came into the country, but it was really just this failed social networking app launched by the serial entrepreneur Liang Changlin, and Changlin had gone through numerous iterations with Dingdong and previous start-ups. He successfully sold a prior start-up to TAL Education in 2016. But Dingdong just never managed to take off. I think it was a flower delivery shop, at one point, breakfast delivery, laundry services. They went through all of these failed ideas before settling on what it is today, which is fresh grocery delivery, and that started in May 2017.

Sharma: That’s crazy, Emily. It’s like if you left the U.S. and came back after three or four years and found out that MySpace had become Amazon Prime grocery delivery. You’d be similarly surprised to hear something that you associated with a not so good social app had catapulted into a dominant player in such a difficult industry, the grocery delivery business.

Flippen: It actually reminds me of what we talked about last week with Vimeo. It’s a similar thing, Vimeo then coming around trying to convince everybody, “Hey, we’re not just this failed version of YouTube, we’re actually a completely different successful SaaS business. The same thing is happening with Dingdong. I will say, they are executing on being a platform for ordering fresh groceries, recently expanding into things like daily necessities. Certainly an attractive market in China, as I think we’ve all learned over the past year, an attractive market no matter where you are. But they take a really unique approach to fulfillment and delivery. You put a lot of notes that are largely above my head, Asit, so I want you to explain how they’re special.

Sharma: Yeah, and Emily, I think the only reason why they seem so is because I spent so much of my previous life looking at like the grocery business and logistics, so unfortunately, the things I really thought were valuable just aren’t in the investment world, but once in a while, you get an opportunity to talk about this. They have an interesting type of fulfillment network, it’s called a frontline network, a self-operated frontline fulfillment network, and Dingdong claims that it’s really better suited for this type of delivery, fresh groceries, if you think about the fast moving consumer goods market, so small items that we would be buying everyday. They also fit into this category a little bit. Missfresh specialized in those items. But daily necessities, as you mentioned, Emily, how do you get those to people at scale if you’re really going to expand across a region of China, you have to rethink the whole business of fulfillment and delivery. I was very interested in this concept. They have 950 of these frontline fulfillment stations in 29 cities. What I love about it is that it borrows from concepts that you’d normally find in the furniture delivery logistics market here in the U.S. In fact, a really great way to think about this is Wayfair, which many investors will be familiar with. Wayfair has a network of what’s called middle mile network warehouses. They call it Castlegate, they have a brand name for it. 

This also, Emily, will remind some listeners of when we talked about Coupang, and how they have so many big logistics centers around South Korea. This model for Wayfair gets its next step in what’s called the Wayfair delivery network. That is, of course, a series of logistics spaces that bring the final product, say a big couch, closer to the consumers, they can make that last mile delivery. That’s what Dingdong has done. They have their own middle mile network, they have 40 regional processing centers that perform the sorting, processing, and packing of raw goods. Don’t confuse this with distribution centers in the United States, that an American grocery or dollar store might use. Something a little bit different. They pull in raw produce and they sort it, they process it, and they pack it there. 

Now, between these processing centers and then the frontline fulfillment stations that bring them very close to the consumer, it’s an expensive model, and it’s going to get real expensive if they can’t get their unit economic costs and pricing just right. However, Dingdong argues in its F-1, and just a refresher, the F is for a foreign filer, same thing as an S-1, basically in offering perspective. They say in that document that this model is superior to the store to home structure that you find all over China where you have grocers and other types of retailers using these third-party deliveries to get their goods closer to consumers right to consumer door steps. I just want to say lastly about this model of distribution and fulfillment, that their fulfillment expenses actually looked like they’re decreasing as the company becomes bigger, so they’re starting to realize some operating leverage from frontline fulfillment. Fulfillment expenses were about 50% of revenues in 2019, that dropped all the way down to about 36% in 2020. We’ve got some evidence here that this innovative model is working.

Flippen: A lot of that does go over my head, but I remember reading through it and taking away a few key points. One of which as I think you did, well, a great job of explaining, is that Dingdong has to take ownership of that inventory. It ends up being a pretty asset-heavy business model that may stand out to some people. For instance, if you are accustomed to looking at Alibaba, whose business’s largely diversified, but if you go back to its core, it was really just pass-through. The margins looked a lot more impressive than something like Dingdong, or JD.com, or even Pinduoduo, all of these Chinese e-commerce businesses. Heading into this business, you can expect a lot of reinvestment into inventory and assets. That’s just to be expected. But to your point, the only way this becomes profitable is by reaching scale, and it scares me. It gives me movie passive vibes where the answer to everything as we go through their financial performance is going to be, “Well, this will be fixed with scale. We just need more scale.” It’s an easy cop out, but it is nice to see those fulfillment expenses decreasing year-over-year as scale happens, because if they’re going to make that argument, that needs to happen.

Sharma: Scale is so interesting, Emily, in so many of the IPOs that we’ve looked at this year. It simultaneously is the answer to producing profitability out of market share, but it’s also pixie dust for a lot of companies. Like you say, it’s a catch-all, magic dust. If we achieve scale, then of course, all these investments are justified, and we intend to increase scale. Let us show you how we’re going to increase scale, but it doesn’t always pan out in the real-world overtime.

Flippen: What I think it’s really interesting about the approach that Dingdong takes, is I know a lot of our listeners are probably scratching their heads and thinking, “Well, why isn’t Alibaba doing this? Why isn’t JD doing this? They’re all a number of a half dozen or so really successful Chinese e-commerce giants. Why aren’t they participating in this space? It’s not that they aren’t, they’re just taking a completely different approach to how they procure those products. The way that Dingdong went about it, which I think is really unique, is they went for products that were really hard to find and that you couldn’t order on different sites. Things like really high-quality fish and meat, fresh produce, the things that customers didn’t quite entrust with the Alibaba’s of the world. Because what they were doing was going to their local market, grabbing something, delivering it to their door. People were like, “Well, yeah, I can do that though.” Dingdong, by going directly to the source, going directly to the suppliers to get the freshest ingredients, I think built up trust with a pretty large swath of active users now.

Sharma: I think so. You mentioned, Emily, in our notes that they have something called a 7+1 quality control procedure that helps them cut out the middleman, or middlemen, or we should say middle persons, in groceries. It keeps just what you are saying, that the supply of goods at a very high quality. I was fascinated by this because it reminded me a bit of another company. I’m sorry if I’m searching for U.S. analogs today. Emily has the benefit and experience of having lived in China. I’m always trying to relate things in China to what I know here. But I’ll go ahead with another one. This reminded me a lot of Whole Foods. Because Dingdong is very keen to form really deep relationships with these higher-quality suppliers, they help farms and co-operative with something called Good Agricultural Practices, or GAP. I believe this must be similar to GMP. If any of you out there have ever worked in a manufacturing environment, which I have earlier in my career, you’re familiar with this idea of good manufacturing practices. They have a proprietary set of procedures that helps, and they call that D-GAP, or Dingdong GAP. I’m sorry, I just love this name. I love all the fun of Chinese businesses. D-GAP simultaneously helps suppliers get better, ensures a consistent, very reliable supply back to the consumer. But it also promotes a lot of loyalty. If you start dealing with Dingdong, the idea is that even as you increase your revenue with them, you’re not going to want to leave. I thought that was a pretty smart way to help grow to achieve scale again, but with suppliers having them grow alongside you.

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Flippen: For anybody who is wondering, the Dingdong name, I think it does have a good American analog here with the doorbell. It does mean that in China as well. Dingdong. Then it’s like, oh, you can buy groceries, you can buy your fresh produce. That’s the idea behind Dingdong Maicai. It’s silly to say it, kind of fun at the same time. The good thing about this unique process that they have, both with quality control and their fulfillment network is this movement toward speedy delivery. We’ve seen this become increasingly critical, especially with third-parties as we look at the Chinese e-commerce market. It’s great to see that Dingdong coming out of this IPO, already has speedy delivery practices in place. They deliver more than one million orders every day with a target delivery time of, I’m going to let everybody think about this for a second. What do you think the target delivery time is? Two days? One day? Try 30 minutes. When we talk about buying fresh meat, fresh fish, fresh produce, that’s the whole point of having these tiny, I don’t want to call them warehouses, because that’s not an accurate description, these frontline fulfillment stations are to get it to people’s stores in 30 minutes. In a lot of cities, there’s no delivery minimums, there’s no order minimums. You can get free delivery every 30 minutes. That’s a really strong value proposition.

Sharma: For sure. I also liked, Emily, that you pointed out how strong their transacting members are. Can you tell us a little bit about this Dingdong membership, which seems to me, a real vibrant part of the business?

Flippen: You can use Dingdong just as a casual user, one-off purchaser. But actually, an increasingly large number of their users are what we call Dingdong members. 22 of their monthly transacting users are members of the Dingdong membership, and they contribute nearly half of the total gross merchandise volume running through the Dingdong network. Essentially, what you do is you pay 88 RMB a year, which is around $14 for an auto renew membership. It gives you things like member-only coupons, discounted prices, I think it’s 12% off Fridays, and better customer service. To use another American example here, it’s like Amazon Prime. You pay up to get a better experience. They have some really crazy impressive repurchase and retention numbers. I love that they provide these numbers. I’ve gotten so accustomed to not getting this type of detail, but there are 12 and 24 month repurchase rates for Dingdong memberships are 64% and 71% respectively. Their total retention rates since inception, which was the second quarter of 2018, is around 50%. I thought those numbers were pretty impressive.

Sharma: I thought so too, especially when you think about how competitive the market is in China and the fact that many people in urban cities, yes, they love online convenience, but they also live very close to really great grocery stores. In the markets that Dingdong plays in, to be able to have people subscribed to the service and hit an overall retention rate of 49%, but even better. Those repurchase rates signal to me that if they can improve that balance rate just a little bit, they already have the locked-in annualized recurring revenue component, if I can pull a term out of the technology sector. They have people that are beginning to feel like, “I really don’t remember what it was like before I started using this product in this app.”

Flippen: I don’t know if it has Couponk level of stickiness. I truly think Couponk’s in a league of its own with its value proposition. But I do think that this is increasingly moving in that direction, and I love it. I will say that getting started in Shanghai has a plus and a negative, I think, to its business. On one hand, Shanghai is an extremely competitive market. They really did commit trial by fire, by going to one of the single most competitive markets you can be in in China, with an entirely new delivery service trying to compete with really entrenched customers with already existing loyalty programs. But the flip side of that is, you’re getting a lot of really high value customers first, which is going to make it hard when they move into lower tier cities in China to get those same levels of stickiness and spending that they can expect from consumers around the Shanghai area.

Sharma: Yes, I love your perspective on this. I am vaguely familiar with tier-1 cities. These are the biggest cities in China. It was interesting in the F-1, when Dingdong talked about where it’s focused. This is the Yangtze River Delta, and this includes not only Shanghai, but many other big cities that viewers will be familiar with: Nanjing, Wuxi, Hangzhou, I hope I’m pronouncing all these right. Emily can correct me.

Flippen: You did a good job, Hangzhou, but close.

Sharma: Hangzhou?

Flippen: Yes.

Sharma: I won’t get into this in detail, but we had ordered something from China and it came from Hangzhou. This was years ago. It was through Amazon. It came with a really beautiful card, which had a proverb about this city and my family used to recite this. My kids were smaller so they might have a ginger ale. My wife and I would be sharing a glass of wine at dinner and we would recite this almost weird verse they had inserted in this. This goes to, I think, China’s real diverse, again, fun loving set of entrepreneurs. But I have a special love of that one city because of that.

Flippen: I love that.

Sharma: I associate it in my memory with toasting around the dinner table. But getting back to business, if you put all these cities together, you get one of the largest collections of adjacent metropolises in the entire world. In this Yangtze River Delta, which I’m going to call the YRD as many people do, that makes it a lot easier for me. In the YRD, you have $2.2 trillion in annual gross domestic product in U.S. dollar terms, and I think that’s actually an old figure. This region produces 24% of the total Chinese GDP and it has a population of roughly a third the size of the US. Agreeing with that point, Emily, in the F-1, Dingdong said that it’s gross merchandise value expanded at a compounded annual growth rate of nearly 320% between 2018 and 2020. The key takeaway here is that for a company to succeed, Emily, it has to leave China for it really to take off. However, you take that fast growth rate and then what happens when you start looking around for the other cities? I was actually a little concerned at the growth prospects. The company stated in its prospectus that this is very positive. They list a city, which again, I’ll need help here, but I think it’s Ma’anshan. Is that correct? Close?

Flippen: Close enough. I’m no expert.

Sharma: This is an industrial city and here in the States it would be a pretty large city. This is about 700,000 people. Very decent per capita expenditure, of RMB 31,000 in 2019. They say that they achieved a faster ramp-up speed here when they went into this city than they did in mature markets like Shanghai. But if that’s the case and we’re now dipping it down into these smaller cities, there is that rural and urban divide which has existed in China forever and still can be very stark once you leave a big metropolitan area or even a megalopolis, like the YRD. You can pretty suddenly be into farmland and not these dense centers with really high per capita income, people that are packed closely together and ready to spend. Emily, having lived in the country and traveled around, do you think I’m over worrying about this or perhaps it could be something that is a little bit of a wall as the company tries to hit that scale we’ve been talking about?

Flippen: I think it’s an appropriate worry and it’s actually interesting. I’m going to derail a little bit and I apologize.

Sharma: Awesome.

Flippen: But it reminds me of an investment I made a few years ago in Pinduoduo and it might be a familiar name to listeners now, the ticker is PDD. But Pinduoduo was an up and coming e-commerce provider, had recently IPO’d, and in a lot of respects is very similar to Dingdong in that they sell what are very low value products and it was a major concern. I saw the sticky social aspect of Pinduoduo that really excited me. But my big concern was the fact that what was flowing through their network were really low value items. We’re talking toilet paper, tissues, not electronics, not big ticket purchases. The company was and still is losing money hand over foot to try to fulfill these really low value products. But I liked the idea. I liked the leadership. The CEO actually recently stepped down, so that has turned out to change a little bit. But the idea was compelling to me. What I did like most about their strategy was they actually were super sticky in Tier 2, Tier 3, even Tier 4 cities before they were in Tier 1. Because people in those areas were a lot more price sensitive. They were willing to buy stuff on Pinduoduo’s platform because they were getting it much cheaper by participating in group buying than they were on Alibaba or JD. I liked that aspect. I liked that they could expand to Tier-1 cities. They haven’t quite taken off in those higher tier cities but they haven’t needed to because the lower tier cities have been growing so much and have been such a sticky audience for them. 

I think in terms of gross merchandise value, they are now the largest e-commerce retailer in China. I agree with your skepticism and I’m especially concerned about their ability to tap into lower tier cities that do tend to be a bit more price sensitive, and tend to care a little bit less about the 30 minute delivery. But at the same time, I went against the better instinct of myself when I bought shares of Pinduoduo and it’s been an amazing investment for me, so I might be willing to cut them some slack.

Sharma: I like that. Taking what looks like it could be a big risk and trying to stick with it for a while and watch the story as it evolves. It’s something that I’m trying to get better at as an investor is not to just turn away when you have that initial burst of skepticism on a rather big front. But to see how management is going to counter that, what they have to offer that could be optionality on the table. I don’t know much about the management team but this would be something if I follow this company more closely, maybe it would be a next level piece of research for me. What about these people who are running the company? What are they capable of? Do they look creative enough and resourceful enough to figure a way to make their unit economics work as they get into the lower consumption areas. I think Pinduoduo, we can talk about that all day. It’s been so fascinating. I do remember you talked about this last year in one of my first live appearances with you, I think, and I have followed it for a while. One of those if you didn’t listen to Emily you missed out, right? Because that turned out well. We won’t bring out any stinkers that you might have had.

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Flippen: Baozun, probably a good example of a stinker that you could compare my investment in Pinduoduo to.

Sharma: I’m just unnecessarily ribbing you today, I think, Emily.

Flippen: I love it.

Sharma: Well, awesome. Let’s talk a little bit about the metrics of this company because they are impressive. I think if you want a foundational thesis to buy a company that is losing money but operates in a really great market, some of these metrics are pointing to that.

Flippen: It’s funny, we normally talk about metrics earlier than we do in this show. I love the fact that we save the metrics for the end here because actually these metrics are pretty crazy good in my opinion. Excuse me, Dingdong, not Pinduoduo. Dingdong has around a 10% market share of the on-demand e-commerce industry in China, which may not sound like a lot, but again, they were largely focused in a very specific area. Pretty new business, so plenty of expansion opportunities as they get into those lower tier cities. They have around seven million monthly transacting users, 70 million total orders, and over 13 billion yuan in gross merchandise value in 2020. As you mentioned, that’s up more than 300% from 2018-2020. But more importantly, that’s more than two times the industry growth rate. You can make an argument that the past few years have been a great time to be in grocery delivery for obvious reasons. It has been, the industry grew 115% over the past two years. But Dingdong managed to more than double that growth which says to me they’re doing something right.

Sharma: The demand is there in this industry for sure. Are the profits there? Well, you do point out, Emily, in our notes, that 6.7 average monthly orders is the unit for transacting users. That’s a lot. If you just divide a month by that, that’s every few days at least one order. This goes back to, I think, the stickiness that you were talking about earlier and it’s convincing to me. Now, that order size is down during the pandemic. Pre-pandemic they were at about 70 RMB, which equates to about $11 per order during the pandemic. We don’t have more recent figures, I don’t think we have first-quarter numbers. I could be wrong here so correct me if I am. Their average order size is down to about 54 RMB for an order or about $8 per U.S. dollar. I don’t think that’s too small an order size if the frequency is there. In fact, just multiplying that out over the year, again, you see the value of a customer and how that can grow. The one thing that I love about China, which offsets my worries about their declining population rate, and this sounds crazy to say, let me take a quick digression here. China being the most populous country in the world, why would anyone worry about their demographics? Well, the one child policy which has now belatedly been expanded and expanded. Now, I believe the latest is you can have three children if you want. That shows no sign of reversing anytime soon. 

You’ve got a shrinking workforce, an older workforce, you have a general population that’s getting older, a lot of gray hairs that the younger generation has to support. It’s actually going to be a problem in China as it will be in the U.S. and South Korea is another great example, Japan is another great example. Almost every continent except for Africa, we’re going to be dealing with the effects of declining populations. All that to say that I love frequency and stickiness and increases per order in a country in which consumption is increasing every year because the wealth is growing per capita every year, that could offset some of the effect of population decline.

Flippen: Yeah, I have to be honest, that average order size of around eight dollars, even if that person transacting six, seven times a month makes me a little bit nervous, largely because it was the same reason Pinduoduo made me nervous. There was a lot of frequency but low value for orders and I just have a really hard time understanding how that business scales. I do think it comes down to their front-line fulfillment network, and just the amount of orders they can push through these fulfillment centers. If they can manage to make it profitable, I think, great. But I want to see the average order size climbing, I want to see that engagement deepening, and the fact that it fell over the course of the pandemic to now says to me, maybe it’s not as sticky, maybe it’s not as valuable as I might have believed.

Sharma: Sure. The next three or four sequential quarters will tell everything, so we’ll see exactly what’s happening with that consumer. Before we wrap this one up, we should talk about finances. I love this because oftentimes we’re talking about finances for 15 or 20 minutes, but we’ve given the big picture here. This is a company that’s growing very fast, as you mentioned before, Emily. Revenue growth of 192% year-over-year from ¥3.9 billion, so about 4 billion RMB to ¥11.3 billion. That’s, for those of you who are curious, about $1.7 billion U.S. last year. But they’re also losing money.

Flippen: As expected. I’m not sure if that shocks anyone. Probably more concerning, their net loss margins have been increasing. As a percentage of revenue, their net loss is actually growing at least over 2021 in comparison to 2020. Now, we’ll always make the argument that 2020 was an abnormal year. Again, maybe I’m willing to give a little bit of grace here for a wonky 2020, it’ll be an interesting metric to continue to watch as we head into 2022. Fulfillment expenses have come down, but their bottom line is certainly not looking any better.

Sharma: Right. I think that you have a point in that without hitting that scale that is so important here, this could be a company that captures market share but never is able to push those profits to the bottom line. I think that the point you made earlier is quite relevant, what happens over the next couple of quarters, you’re going to be watching that average order size, I will be doing the same. I think this is a company that I’m interested in following, so order size, maybe even a little more up-take in the frequency, and let’s see now with a reset. In China, certainly, you have a great reset in terms of a normalized economy, a post-COVID economy; let’s see what happens in terms of adding on more users as well.

Flippen: Definitely. It will be an interesting one to watch. Before we move on to Missfresh here, I always tend to touch on the risk factors and it just occurred to me right now that I didn’t put any risk factors in our outline. I would quickly note the most obvious risk factor, which is a lot of uncertainty around China right now. A lot of people listening might even be thinking to themselves, “Well, why do these businesses want to IPO in the United States? Why aren’t they just going to the Shanghai Star Index or the Hong Kong Stock Exchange?” Well, they both certainly need and want money, both Missfresh and Dingdong are producing net losses, they need capital to continue running their businesses. At the same time, there are some legal structures, I think, that exist in the U.S. that can make it a more attractive place to list even if it ends up being that they have to transfer their listing later on. One of those being the dual-class share structure that Dingdong is taking advantage of; co-founder, CEO wants to retain ownership of the business. This isn’t something that’s looked fondly upon in the Shanghai market or even the Hong Kong Stock Exchange. They want to list here in the U.S. largely to get the benefits of, at least my perception is, to largely get the benefits of a dual-class listing structure. But there’s also notes, and I see that you added here, one Asit at about the free-rider issue that exists in the United States that can start to exist in China as well.

Sharma: One of the risks that I just wanted to highlight before we move on, it’s not one that’s obvious but it is central to both Dingdong and Missfresh. Now, they both use outsourced riders. Not to be confused with an insurance rider, but these are delivery people on motorbikes and scooters. [laughs] In the US, it’s drivers, and in China, oftentimes, it’s riders because of the compactness of the cities. This is a key to both companies eventual profitability, being able to outsource the delivery component because if you decide that you’re going to employ all these riders, that adds a lot to the expenses that you have in your overhead and in terms of benefits, insurance, we’re all familiar with this, anyone who’s worked a job in the US gets this. In both countries, we have the rise of the gig economy where people are taking on part-time gigs and side hustles and some people are turning these side gigs into full-time jobs. You are a full-time Uber driver, that is in the U.S., or you’re delivering for different e-commerce retailers in China, you can work for just one. If you are a rider, you can work for more. This is so interesting because, in China, the third-party delivery riders often tend to be overworked, some have committed suicide. It’s been very controversial about the low rate of pay that exists in the structure in China. This is not just a wage issue but it’s also becoming something a bit larger because there is an activist movement within this industry of delivery people. I think in spring one of their leaders mysteriously disappeared, just as in Hong Kong when the protest got hot, some of the journalists temporarily disappeared, and I think one of the publishers in Hong Kong, same thing happened to him. This is a risk to keep your eye on if you are investing in this space. 

The other part of it, which is not as visible, is very similar to what’s going on here in the U.S., in that the Chinese government could step in and regulate delivery riders and it could force companies to classify these as employees, so companies wouldn’t have a choice to say, “We’re just going to use this contract labor at a cheaper rate.” They would have to employ drivers. The only company that I know, and I’m by no means an expert on this industry in Asia, but the only one I’ve come across is, a recent conversation about Coupang, Emily. Coupang employs a good portion of its delivery workforce, but not so in China. It’s just something to be aware of, that rising tensions because of low wages plus a potential implication for overhead, benefits, taxes that are due on workers, something that could shift the outlook for a company that relies on fulfillment model because yes, you can have all types of variation on logistics, distribution, last-mile fulfillment, Missfresh has its own take, which we’ll discuss in just a moment here, but without this ability to pay a very low rate for the labor component, most of these models aren’t going to work over the long term.

Flippen: I love that. To move on to Missfresh quickly here, I’m going to color my opinion, and everybody listening’s opinion about Missfresh right off the bat, not even giving them an opportunity here to defend themselves. I’ll say this, I went through Dingdong first, went through Missfresh second, and was taken aback by how stark the difference in performance between the two businesses was. But I’ll tell you what irritated me the most. Missfresh kept using the acronym DMW and everywhere I read DMW, DMW, our DMWs, and had to go to the appendix or index where they list all their terms to find out what this meant, they only clarified it there, it’s a distributed mini-warehouse. I’m convinced if you need to come up with a cute little acronym to describe your very non-unique business structure, you’re trying to cover for something. I was already turned off of this business within the first few pages.

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Sharma: It’s funny you should mention that, Emily, because certainly, I was Control-F-ing. Now, you all, this is a PG-rated show. I’m not getting shorthand for cursing, I’m not dropping an F-bomb here. Control F is a function on your keyboard if you need to search for something, so I wasn’t cursing because I couldn’t find this acronym, I was hitting Control button and F to see where this was explained. Then I Googled it and it was not in the first page of search results either. Now, I have the benefit, dear viewers and listeners on the podcasts, in that I have Emily Flippen to explain to me what DMW stands for, but that also took me aback because it was what I call […] which is when you drop a big term at the beginning because you feel that everyone in the world should know about your company and how you’ve innovated. It turns the reader off. The way you should do it is to explain the term and then say, “Yes, we actually pioneered this, by the way, we’re very proud of it. Of course, we have worthy competition with their own creations and strategy.” This is a little bit in your face, isn’t it?

Flippen: I’m getting such a chuckle by the fact that you experienced this as well because we didn’t write this out, guys. Both of us read through the F-1 independently and I love the fact that we both had this problem. It is, in my opinion, certainly overcompensating, but this is petty, I’m not going to lie, I’m a petty person, this is a petty complaint to have about a business. But I know you’ve done more research into these DMWs than I have, Asit. Is there anything actually exciting here?

Sharma: Well, let’s give them the benefit of the doubt. A distributed mini-warehouse, basically is a cold storage unit and it’s used to move fresh grocery goods directly to the consumers. They actually have a pretty fast delivery time as well. It’s not quite Dingdong, but their average delivery time is 39 minutes. They have an emphasis with this model on serving neighborhoods. They place these DMWs in high-density neighborhoods with pretty decent per capita income, I wouldn’t call them always affluent areas, but they do avoid neighborhoods where the buying power just isn’t there. They’ve got an app called Missfresh, so just like the company name, their mobile app allows users to order from about 4,300 SKUs, and most of these feature fresh produce. Remember, Emily told us that Dingdong had what? Three or four times this number, I think 11,000 or 12,000 unique SKUs. It’s a smaller offering. They’ve invested a lot in smart supply chain, smart logistics, and AI, artificial intelligence, enhanced marketing, but everyone does. 

In this day and age, I will tell you, from spending some years studying the grocery industry, you can’t really compete today without having a smart supply chain that’s informed by machine learning. I guess the one thing that I can say, to give them some credit here, is they’re using this knowledge and expertise that they’ve gathered in building their personal take on something a little bit similar to frontline delivery. They’re trying to leverage that and help brick-and-mortar retailers. Now, the first instance of this, I was actually pretty fascinated by it’s not going to be a big part of their business, but it is cool. It’s called intelligent fresh markets. In China, they have these really popular fresh markets which people go to not just to buy their groceries but to socialize. I think that Missfresh had a key observation that these are going away because people love to go to them, they love the touch of the product. Yes, the online e-commerce industry in China is growing at a rapid pace but the sector that we’re looking at today, which is the grocery space, even though it’s growing at that 115% rate every year, it’s never going to displace completely the love that the Chinese have of going to the market, looking at their goods, touching them, chatting with neighbors. Their take on this was to think about the vendors and the spaces. Missfresh realized that, “Hey, we can apply our technology, we can change the four plans of existing fresh markets into smart fresh malls.” There’s that word smart again. Why do they have to keep saying smart? Why can’t they just say innovative fresh malls? But anyway, let me proceed. 

By just reconfiguring the floorplan, making it a little bit more accessible, so people could get through in a bit better fashion than sometimes the frenzied and maze-like patterns you have to go through in existing markets which might have been around for a long time. They provide the vendors there with a software-as-a-service-based platform that helps them take electronic payments and gives them customer relationship management tools and even helps these vendors utilize the bigger Missfresh platform so they can monetize their products a little further. They’ve got contracts to operate 54 of these fresh markets in 14 cities in China. They launched this in the second half of 2020, they’re already operating 33 markets in 10 cities and they’ve got this one additional business line which is to help local retailers and grocery stores participate in the online delivery arena. They just enable them to sell retail via their e-commerce model. They call this their retail cloud services business, and that was launched earlier this year. Now, I have a note about both of these here, Emily, that the company says each of these streams is just there to help improve their gross margin profile. They don’t even say that this is going to be a significant impact to revenue, it’s all about improving existing poor margins. It’s hard to say anything tangible about this except saying the following, I should say it this way. These are really cool ideas, but they’re not going to have a huge economic impact on the company’s current financial structure. It was almost like a little bit of a distraction that management realized they may not achieve the scale that they need and now they’re going into a frenzy pace to have a strategic reset and they’re looking around, like how can we use our technology in a way that won’t totally cause us to recreate the wheel? This is what they’ve come up with. Again, it sounds cool but what will it really do to a company that has a loss margin that’s around 27%, meaning thereby, they’re losing about $0.27 for every Yuan that they sell.

Flippen: Here’s your Flippen conspiracy for the day. I think part of the reason why this business is interested in listing on the U.S. Exchanges is, U.S. Exchanges are less aggressive against things like AI and smart technology in comparison to foreign exchanges. We regulate these terms less, and in my opinion, distraction is probably a good way to describe these numerous business lines. Well, we’ve run out of time here on Missfresh. I’m going to sum up, just really quickly, some more of the reasons why I don’t like the business. They break out annual transacting users as opposed to monthly or weekly. I don’t know about you, Asit, but I eat more frequently, I order groceries more frequently than on an annual basis. That metric to me is pretty meaningless. But perhaps most importantly, is not only their numerous business lines, which includes a dying vending machine business, which in my opinion is a hallmark of Chinese business scams that they own vending machines, but they actually had revenue and active customers fall year-over-year, whereas we just talked about Dingdong, which grew active customers and revenue 40% and 46% year-over-year respectively. You compare those two businesses, there’s really only one winner in my mind.

Sharma: Yeah. Now to be fair, I should say that Dingdong has a very similar loss margin when you look at the bottom line; I think theirs is 29%, and Missfresh, now I have it here, it’s 27%, I might’ve said 28%, so really similar loss margins. Dingdong even has a higher fulfillment expense per RMB of revenue at 32% than Missfresh does at 25%. But guess what? Emily, without that top-line growth, you really can’t convert this model into anything that’s going to stick around for a long time. Now, maybe they will be able to pivot, and maybe they will be able to use their public offering. I’m talking about Missfresh here, to raise capital to fund losses for additional years. But there really isn’t any visible path to this company returning a lot for shareholders if they can’t grow revenues at an appreciable clip and they’re just going after market share without any kind of momentum on the top-line. That just seems like a recipe for potential disaster and I’m not being flip here to use the word because we’ve seen this play out in some Chinese companies. One which actually had a fraudulent component was Luckin Coffee. I don’t mean to cloud these issues, but I will say if you take away the fraudulent accounting issues that Luckin had, it was also in a race against time initially. I think that what’s left of that company now has been able to restructure and it’s much smaller, it’s growing at a more realistic rate and not just trying to grab market share. But this just looks like a market share grab with nothing beneath it.

Flippen: Oh, and guess what? Luckin Coffee had vending machines too.

Sharma: There you go. Takeaway here, if you see the word vending machine mentioned in a F-1 originating from China, Emily says and I think I second her here, pay attention, it could be a sign of some desperation.

Flippen: If I wanted to own a vending machine, I’d own a vending machine, I don’t need to buy your stock to do that.

Sharma: True that.

Flippen: Well, Asit, thank you so much for joining me. It’s always a pleasure.

Sharma: Same here, Emily. I really appreciate it and this was so much fun.

Flippen: Listeners, that does it for this episode of Industry Focus. If you have any questions or just want to reach out to say “Hey,” feel free to shoot us an email at industryfocus@fool.com or tweet at us @MFIndustryFocus. As always, people on the program may own companies discussed on the show and The Motley Fool may have formal recommendations for or against any stocks mentioned, so don’t buy or sell anything based solely on what you hear. Thanks to Tim Sparks for his work behind the screen today. For Asit Sharma, I’m Emily Flippen. Thanks for listening and Fool on!

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.



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