Dingdong Rings On Its East China Base To Fatten Profits

Key Takeaways:

• Dingdong’s revenue fell 27% in the second quarter as business returned to normal after a surge in the year-ago quarter at the height of China’s Covid lockdowns
• The online grocer recorded strong growth for its membership services, and is retooling its geographic footprint to focus on its profitable base in Shanghai and surrounding areas

By Doug Young

Leading online grocer Dingdong (Cayman) Ltd. DDL is emerging as a battleground between investors, who are quite negative on the company, and an analyst community that is quite positive. That growing divide was on display last Friday after Dingdong announced its latest quarterly results, which sent investors scurrying for the door, even as the 10 analysts who followed the company all rated it a “buy” or “strong buy.”

So, why such strongly differing views?

The answer appears to lie in a broader lack of respect for grocers in general, which operate on extremely thin margins due to stiff competition in their highly commoditized business. Dingdong once excited investors with its China story, making them believe it could quickly scale up to dominate a huge China market with 1.4 billion mouths to feed.

But the reality has been quite different, as evidenced by Dingdong’s latest results that show it is struggling in just about all parts of China except for its core base in Shanghai and the surrounding Yangtze River Delta region.

The company listed in the U.S. a little over two years ago, selling American depositary shares (ADSs) for $23.50, valuing it around $5 billion. Since then the stock has moved steadily downward as the company posted growth that was relatively strong, but not strong enough to meet unrealistic investor expectations. The stock fell another 7.3% last Friday after the latest quarterly announcement, sending it to an all time closing low of $1.90.

At its current level, Dingdong’s stock looks quite undistinguishable from other major grocers, both Chinese and foreign, in terms of valuation multiples. It currently trades at a meager price-to-sales (P/S) ratio of 0.13, which is just a tad below the equally low 0.19 for Sun Art (6808.HK), operator of the popular RT-Mart supermarket chain. U.S. giant Kroger KR trades only marginally higher at a P/S ratio of 0.22.

Despite being viewed by investors like other grocers, Dingdong is taking steps to try and get valued less like Kroger and more like an Amazon AMZN, which moved aggressively into the grocery business in 2017 with its purchase of supermarket chain Whole Foods.

Like Amazon, Dingdong is trying to turn more of its users into members, taking a cue from Amazon’s huge success with its Amazon Prime service. The company is making big strides in that direction, noting that members accounted for 54% of its gross merchandise value (GMV) in the second quarter, up 10 percentage points from a year earlier. It added that ordering by members also rose 9% during the quarter year-on-year, indicating that such members were spending more time and money on the platform.

Dingdong is also trying to differentiate itself from other grocers by moving away from ordinary fresh foods into higher margin businesses like private-label products and prepared meals. Since making a strategic shift to that focus two years ago, the proportion of non-fresh food in its product mix has risen 7 percentage points, the company said on its earnings call.

“Our existing member benefits such as free dishes, member-exclusive products, member-exclusive discounts, and super member days are just the beginning,” said founder and CEO Liang Changling on the company’s earnings call. “We’ll continue introducing even more benefits to incentivize and reward our loyal members.”

Meager Profits

The need for higher-margin products and fatter profits isn’t exactly urgent, since Dingdong has plenty of cash, with 5.52 billion yuan ($762 million) in its coffers at the end of June. It’s also very close to breaking even. Instead, the greater urgency is to convince investors that the company can become a profitable grocer with fat margins, which means it may ultimately need to give up on its earlier strategy of being a “grocer for all.”

That internal conflict was evident in subtle ways throughout its latest report, including its discussion of recent changes to its geographic strategy that will target China’s wealthiest cities and de-emphasize less affluent areas.

The company’s overall revenue posted a sharp 27% decline during the second quarter, falling to 4.84 billion yuan from 6.63 billion yuan a year earlier. While such a decline would normally look worrisome, it was largely due to a very strong year-ago quarter in the spring of 2022. Many will recall that Chinese turned to Dingdong and other delivery companies en masse at that time during widespread lockdowns under China’s “zero Covid” policy that has now been scrapped.

A fairer comparison would be the second quarter of 2021, when Dingdong’s revenue totaled 4.65 billion yuan. While the latest figure was above the figure from two years ago, it was only ahead by 4%, which isn’t a very strong gain for a two year-period.

The company’s operating costs also fell by about 27% in the second quarter year-on-year as business returned to more normal levels. As a result, Dingdong’s net loss for the quarter totaled 36.6 million yuan, roughly the same as its 34.5 million yuan loss a year earlier. The company noted that it posted its third consecutive quarterly profit on a non-GAAP basis, which excludes costs related to stock-based compensation.

On its earnings call, Dingdong acknowledged its withdrawal from Southwest China’s Chongqing and Chengdu markets in May, calling the moves “temporary.” CEO Liang also discussed a plan to “improve our operating capabilities in North China and South China in the second half of the year,” suggesting those regions also were underperforming.

The company’s only profitable region is its home in Shanghai, along with adjacent Zhejiang and Jiangsu provinces, which it collectively refers to as East China. It indicated it will place its greatest focus on that region, which is one of China’s wealthiest, and will use its profits in those markets “to provide support for the development of our operations in North and South China.”

We wouldn’t be surprised to see Dingdong leaving other markets soon to focus on developing its membership services and higher-margin products from the safety of its East China base. Some might view such a move as a setback for a company that once had the potential to become a major nationwide grocer. But in our view, it looks like a prudent move to sharpen its focus and bottom line, before perhaps eventually returning to these markets later with a more targeted and profitable business model.