The online grocer trimmed its non-GAAP net loss by 86% in the third quarter, but also reported its first-ever revenue decline as it focused on cost controls and higher-margin products

Key Takeaways:

  • Dingdong’s non-GAAP net loss narrowed by 86% in the third quarter, as it reiterated its goal of achieving breakeven on that basis by year-end
  • The company’s gross margin improved markedly on strong cost controls and a focus on higher-margin products

By Trevor Mo

Ever since leading online grocer Dingdong Cayman Ltd. (DDL.US) reported its first ever non-GAAP profit in the June quarter, observers have been asking if it can do it again over the long-term. The question has gained urgency as its top rival Missfresh Ltd. (MF.US) now fights for its survival after years of burning through investor cash that left its coffers dry. 

Dingdong’s answer to the question is an adamant “yes,” which company management made to investors following release of its latest quarterly results last Friday by reiterating a previous pledge to achieve non-GAAP breakeven by year-end. Its latest results included big movement in that direction with an 86% narrowing of its non-GAAP net loss, a commonly used metric that typically excludes employee stock compensation and some other costs.

Investors liked what they heard, with Dingdong’s shares rising 47% in the three trading days after the release of its results, including a nearly 20% jump the day of the announcement. Still, the stock’s latest close of $4.35 is down significantly from its IPO price of $23.50 last June, and just a fraction of its $30 peak reached in late 2021.

While the results seem to show the company is indeed inching towards longer-term profitability, we should also point out that much of that improvement is being driven by cost-cutting, which may have partly led to its first-ever revenue decline in its latest results.

We’ll take a deeper dive into Dingdong’s third-quarter results shortly, and also look at some of the major challenges it faces in its quest for long-term profitability. But first let’s step back and review its path to the present, including its very-fast delivery business model that helped to fuel its rapid rise but was a growing source of investor concern due to its heavy investment requirements.

Dingdong belongs to a group of grocery e-commerce companies using a “frontline fulfillment grid” business model. That relies on networks of hundreds of warehouses personally operated by the company near residential areas, allowing it to rapidly deliver groceries to consumers’ homes, usually within 30 minutes of an order’s placement.

Companies using the model say it offers more reliable and faster service due to their strong control over their supply and delivery chains. But such control comes at a price, since the model requires ownership of everything from product sourcing networks, to warehouses and delivery fleets. 

Dingdong has used that model to develop quickly since its founding in 2017, tripling its revenue from 3.8 billion yuan ($540 million) in 2019 to 11.3 billion yuan in 2020, and then nearly doubling that amount again last year to 20 billion yuan. But heavy investment to achieve that growth also caused its losses to balloon, doubling last year to a staggering 6.4 billion yuan loss from the 3.2 billion yuan loss in 2020.

Delivering profits soon? 

With that big picture background in mind, we’ll take our deeper dive into the company’s latest quarterly earnings that showed the big improvement in the company’s bottom line.

In a major shift to improve its profitability, Dingdong adopted a self-described “efficiency first” strategy in last year’s third quarter that included a healthy dose of cost controls. Under that strategy, the company has made significant improvements in its two major cost categories – fulfillment expense and sales and marketing expense. Specifically, the two ratios as percentage of revenue dropped by 10 and 5 percentage points, respectively, during the latest quarter.

The cost cuts helped to fuel a significant improvement in the company’s gross margin, which soared by 11.8 percentage points to about 30%, versus 18.2% a year earlier. The margin also got a boost from Dingdong’s growing focus on more profitable product categories, including private label products, prepared meals and self-processed food, according to a research note from investment firm Jefferies.

The cost-cutting, focus on higher-end products and resulting margin improvement helped Dingdong significantly pare its third quarter non-GAAP loss to 285 million yuan from nearly 2 billion yuan a year earlier.

But the big bottom line improvement came at a cost, as the company reported its first-ever decline in its top-line revenue, which fell 4% to 5.9 billion yuan in the latest quarter. It blamed the drop largely on a high base for the year-ago period, which was boosted by “extensive subsidies and concessions granted to our users”, management said on the investor call.

While the company is aiming to breakeven by year end on a non-GAAP basis, investors also want to know when it will become profitable on the more standard GAAP basis. Chief strategy officer Le Yu refused to give a timeline when asked about that milestone on the investor call, only saying “there is no doubt that Dingdong can achieve profitability.” 

Many analysts covering Dingdong believe it will achieve its non-GAAP breakeven goal on schedule. Daiwa Capital Markets said in a research note it expects Dingdong’s breakeven goal will come earlier, with its non-GAAP net loss margin already turning positive due to “gross margin improvement from favorable category mix.” Jefferies analysts were more cautious, saying in a note that Dingdong’s non-GAAP net loss margin will be -2.7% in the fourth quarter before turning positive in 2023.

Analysts at Daiwa Capital Markets said they expect Dingdong’s net cash to stabilize at current levels, which should ease concerns about any potential liquidity crisis. At the end of September, the company had cash and cash equivalents and restricted cash of 1.4 billion yuan, less than half the 3.1 billion yuan it had a year earlier.

At the end of the day, whether Dingdong will be able to achieve profitability will depend on how many of its initiatives bear fruit, including its continuous cost-cutting and the ramp-up of higher-margin products. Despite trying many of those, a similar effort by Missfresh ultimately failed and resulted in the company’s dramatic unraveling.

Even after the recent rally for its shares, Dingdong still trades at a lowly price-to-sales ratio (P/S) of just 0.24 times. That’s well below Meituan’s (3690.HK) P/S ratio of 4.6 times, as well as Dada Nexus (DADA.US), which trades at 0.88 times.

Both Meituan and Dada use a more asset-light business model by simply operating online platforms connecting offline stores and shoppers. The differences in P/S ratios suggests that investors might prefer the latter model, which puts far less strain on a company’s finances than the frontline fulfillment grid used by Dingdong.

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