After years of shopping around, Dingdong bags formula for profits

The online grocer reported its third consecutive quarterly profit in the three months to September, and now boasts profit margins similar to Walmart and Kroger

Key Takeaways:

• Dingdong’s revenue rose 27% in the third quarter, while it reported its third consecutive quarterly profit
• The online grocer has tweaked its business formula to focus on more affluent markets, especially in the Yangtze River Delta area where it is based

By Doug Young

It’s been a long trip down the shopping aisle for online grocer Dingdong (Caymen) Ltd. (DDL.US), which has rung up billions of yuan in losses since its founding in 2017. But after trying out a number of formulas, the company has finally found a recipe for sustainable profits, setting it apart from its many peers that are mostly losing money in China’s huge but extremely competitive grocery market.

Dingdong logged its third consecutive quarterly profit in the three months to September, reporting 133.4 million yuan ($18.6 million) in net income for the period, according to its latest results released on Wednesday. The company has been consistently in the black this year since reporting a 12.3 million yuan profit in the first quarter. That grew to 67.1 million yuan in the second quarter, meaning the latest figure represents a doubling on a sequential basis.

Dingdong has done quite a bit of fiddling with its formula since its relatively recent launch just seven years ago. Like many of its peers, it became mesmerized with the huge size of China’s grocery market and initially tried to be a grocer for everyone, from the biggest mega-cities like Beijing and Shanghai to China’s many smaller cities.

But it discovered those smaller cities were far more cost-sensitive than the larger ones. That put it at a disadvantage to rivals like PDD (PDD.US) and Meituan (3960.HK), which achieved significantly lower cost structures by outsourcing most of their grocery business to third parties. By comparison, Dingdong handles most functions itself, from warehousing to delivery, which provides more consistent quality and service levels but is also more costly.

Dingdong discovered that customers in big cities like Shanghai and Nanjing are willing to pay such premiums for better service and product consistency, unlike folks in smaller towns that are more interested in rock-bottom prices. Accordingly, it began withdrawing from smaller markets a couple of years ago, and has focused on cities in the relatively affluent Yangtze River Delta region of Zhejiang and Jiangsu provinces, as well as Shanghai, where it is based.

As it shifted focus, it has increased its store density in those relatively affluent areas to better serve its customers there. At the same time, it has tried to focus more on premium offerings, including its own private label products, which typically carry higher margins than standard groceries like vegetables and staples like rice and flour.

The success of that formula is showing up most clearly in Dingdong’s net margins, which have improved steadily from 0.2% in this year’s first quarter, to 1.2% in the second, to a relatively fat 2.0% in the latest reporting period. To put that in perspective, Dingdong’s latest margin outpaces the 1.37% for U.S. supermarket giant Kroger (KR.US) in its latest quarter, though it still trails the 2.66% for Walmart (WMT.US).

Still, it’s not bad when you can play in the same leagues as two of the world’s largest supermarket operators. By comparison, most of Dingdong’s publicly traded Chinese rivals, including brick-and-mortar supermarket operators Sun Art (6808.HK) and Yonghui (610933.SH), are losing money and thus have negative net margins.

Shareholders celebrate

Investors welcomed Dingdong’s fast-growing profits by bidding up its stock 13% the day the results were published. That gain was all the more impressive since most U.S.-traded Chinese stocks fell sharply that day on concerns about their prospects after the election of Donald Trump as the next U.S. president.

The rally sent Dingdong’s American depositary shares (ADS) to a close of $4.45, their highest level in the last 20 months. Here, however, we should still note the stock is down about 80% from its IPO price of $23.50 in 2021 just before sentiment turned cold on such U.S.-listed Chinese companies. The stock currently trades at a forward price-to-earnings (P/E) ratio of 18, ahead of the 13 for Kroger and not too far behind Meituan’s 22.

Significantly, analyst sentiment towards the company has rapidly improved since the start of the year. Six of nine analysts polled by Yahoo Finance now rate the company as a “buy” or “strong buy,” up from five at the start of the year. And more importantly, those analysts have upgraded their revenue forecasts for the company this year to 9.8% growth, or more than double the 4.3% growth they expected at the start of the year.

The company’s revenue rose far faster than either of those rates in the third quarter, jumping 27.2% to 6.54 billion yuan from 5.14 billion yuan a year earlier, according to the results. The company attributed the strong growth to people placing larger orders, and also an expansion of its network in the Yangtze Delta area. On its earnings call, it pointed out that 13 smaller markets in the Yangtze Delta area experienced year-on-year sales growth of more than 50% in the latest reporting period.

The company didn’t provide very specific guidance on the final three months of the year, but said it is “anticipating considerable year-over-year growth for the fourth quarter and this year.”

A big chunk of Dingdong’s expenses come from the cost of the groceries it sells, which is relatively difficult to lower as a percentage of revenue. But it has more control over fulfillment costs, such as warehousing and delivery. As it honed its focus, it was able to lower those fulfillment costs to 21.4% of its revenue in the latest quarter from 23.2% a year earlier, which was a primary factor behind its ability to post such impressive margins and profit.

Growing analyst bullishness on the company probably reflects not only the fact that Dingdong has honed its formula to be more efficient, but also the increasing cost-consciousness of Chinese consumers as the economy slows. Restaurants have felt the pinch of consumers eating out less, which is playing to the advantage of grocers like Dingdong that cater to cost-conscious people who eat at home.

Dingdong is now solidly cash flow positive, which allowed it to build up its reserves of cash and short-term investments to 4.3 billion yuan at the end of September from 4.16 billion yuan a year earlier. There’s really nothing stopping Dingdong from building on its recent momentum, as it looks quite well positioned with its current business formula and could even benefit from the increasing climate of consumer caution.

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