Shenzhen Pagoda reportedly hopes to raise $500 million, aiming to attract investors with its booming online business

Key takeaways:

  • China’s biggest fruit retailer Shenzhen Pagoda has filed for a Hong Kong IPO, following two previous failed attempts to list in Hong Kong and on the mainland’s A-share market
  • Company’s online retail sales have helped keep revenue growing despite pandemic store closures, but are also dragging on profits

By Li Yaoyao and Jony Ho

Online distribution channels can help traditional retailers boost their revenues. But getting a similar boost for their profits is a different story. That’s the bottom line coming from Shenzhen Pagoda Industrial (Group) Corp. Ltd., a company that calls itself China’s “fruit McDonalds,” which has found big sales but also negative profit margins in its booming online business.

Shenzhen Pagoda submitted its prospectus for a Hong Kong IPO last week, following two failed attempts in the mainland’s A-share and Hong Kong stock markets in the past two years. This time it plans to raise $500 million, according to local media reports.

China’s wholesale fruit market is highly fragmented with a wide range of distribution channels, from wholesale markets to chain stores, mom-and-pop stores, supermarkets and e-commerce platforms. Chain stores take up less than 5% of retail distribution. According to market data cited in the company’s prospectus, Shenzhen Pagoda is the biggest fruit retailer in China based on total retail sales, even though it accounts for just 1% of the market. The top five retailers combined have just a 3.6% share.

The company has over 5,300 stores in more than 130 cities and 22 provinces across China, mostly in heavy traffic areas near residential and commercial districts. It complements that brick-and-mortar presence with diverse online distribution using its own mobile app, a WeChat mini-app, leading e-commerce platforms like Alibaba’s (BABA.US; 9988.HK) Tmall and (JD.US; 9618.HK), as well as popular social media platforms like TikTok. The company also partners with third-party food-delivery platforms like Meituan (3690.HK), Koubei and, using their local courier fleets to quickly deliver fruit ordered online.

The Covid-19 pandemic and resulting lockdowns in many cities haven’t taken a big toll on the company’s revenues these past two years thanks to its online activities. In fact, its revenue even grew from 8.98 billion yuan ($1.33 billion) in 2019 to 10.29 billion yuan last year, boosted by a nearly nine-fold surge in online retail sales over that period. But its 2020 net profit of 45.68 million yuan was down 82.5% from the previous year, mainly due to rising marketing and R&D expenses. Last year saw that figure rebound to 226 million yuan, bringing it back near the pre-pandemic level.

Negative online margins

The company’s gross margins vary widely based on channel type, led by an impressive 27.3% for its self-operated stores. But its franchised stores have lower margins, and its online business – while bringing in big revenue – had negative gross margins of -4.9% and -0.3% for the past two years. The latter two types pressured the company’s overall gross margin last year, which was just 8.6%. So, access to online channels is clearly a double-edged sword, providing big revenue but not necessarily boosting profits.

Founder Yu Huiyong established the brand in 2001 and opened his first store in 2002 in the southern boomtown of Shenzhen. He coined the term “fruit McDonald’s in an interview, saying the company would expand first from offline to online and then broaden its business scope to cover all categories of fresh groceries in imitation of U.S. e-commerce giant Amazon (AMZN.US).

The company launched its second “five-year plan” in 2016 with a goal of having 10,000 stores and 40 billion yuan in annual sales by 2020. But that plan became a casualty of the pandemic. By the end of last year, the company had just 5,351 brick-and-mortar stores, mostly franchisees. Its average revenue per store fell from 2.08 million yuan in 2019 to 1.96 million yuan last year as the pandemic undermined operational efficiency.

The company said in its prospectus that many of its stores in pandemic-affected areas had to shut down due to quarantines and other restrictions over the last two years, but that it continued to get orders online. Yu once committed to not slashing payrolls during the pandemic, and has boasted of becoming the world’s biggest fruit business. He has said the company hopes to one day claim as much as 10% of the China market, though obviously that goal is still a long way off.

Scandal tainted?

The latest IPO attempt comes as the company grapples with a scandal sparked this month by a blogger’s allegations that some of its stores were selling stale or expired fruit – a practice that isn’t uncommon in China and a problem that has also dogged other major chains. The company investigated, and subsequently shut down the stores involved and suspended those responsible. It also issued an apology on social media, saying that it was sorry that it failed its customers, while promising to strengthen supervision and training to protect customer interests and improve their shopping experience.

Such scandals aside, the company has been a tastier choice for investors over the years, attracting money from the likes of Tian Tu Capital, CICC, Shenzhen Capital Group, Guangzhou Yuexiu Financial Holdings (000987.SZ) and China Merchants Fund Management. Its most recent equity transaction came last October when the Shanghai M&G Start-up Investment Center purchased 2.06 million shares at 8 yuan apiece, for a total of 16.5 million yuan. Its total count of 1.5 billion shares and a net profit of 226 million yuan last year give it a price-to-earnings (P/E) ratio of 53 times based on a valuation of 12 billion yuan.

To put that in perspective, one of its major competitors Chongqing Hongjiu Fruit secured a valuation of 7.59 billion yuan after its latest fundraising, giving it a P/E ratio of 26 times based on its 290 million yuan profit last year. Great-Sun Foods (603336.SH), which processes and delivers fruit, had a P/E ratio of 47 times. That shows Shenzhen Pagoda is getting a premium for its market-leading status.

Shenzhen Pagoda isn’t China’s first fruit company to seek an IPO. Another leading company, Zhejiang Xianfeng Fruit, has been trying to list on one of China’s A-share markets since December 2019, but has yet to succeed. Chongqing Hongjiu also filed for a Hong Kong IPO after aborting an A-share bid last year. Backers of that pair include investment giants Sequoia Capital and Alibaba, respectively.

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