BABA.US 9988.HK
A Freshippo store

The Alibaba-backed chain’s announcement of 12 new store openings kicks off a publicity drive in the run-up to an IPO by the end of 2023

Key Takeaways:

  • Freshippo’s announcement of 12 new stores may represent an acceleration of shop openings in the run-up to its Hong Kong IPO
  • The company’s focus on online orders delivers higher revenue-per-store than its peers, but also carries higher costs for its own delivery fleet

  

By Doug Young  

Investors hungry for something new from China’s grocery scene could soon have two fresh choices, delivered by the nation’s top two e-commerce companies.

The larger of those, Alibaba’s (BABA.US; 9988.HK) Freshippo, made headlines when it announced the opening of 12 new stores last week, as it seeks to start drumming up publicity for a Hong Kong IPO set to take place by the end of next year. Such a move would normally be a non-event since the actual number of new stores is relatively small, representing a modest 4% addition to the chain’s current count of about 300 stores.

The announcement came just days after Alibaba’s rival JD.com (JD.US; 9618.HK) unveiled a plan to spin off its own similar 7Fresh grocery chain into a new innovative retail division. While no IPO plan was mentioned, JD.com has a history of separate listings for its various divisions, such as its JD Health (6618.HK) and JD Logisitcs (2618.HK). Such a strategy makes each separate business entity more transparent and also responsible for its own profits.

7Fresh is quite a bit smaller than Freshippo, with around 50 stores at the middle of last year. JD actually announced lofty plans to open 1,000 outlets within three to five years of the chain’s launch around 2018, which just goes to show how Chinese companies love to give bold forecasts for their growth. Though in all fairness, the pandemic probably threw a major spanner into those plans.

Based on 7Fresh’s much smaller base, it’s probably safe to say that investors may have to wait a bit longer for its eventual IPO, perhaps at least another two to three years. That means Hippofresh is likely to offer up the first major new Chinese supermarket choice for investors since online-only grocer Dingdong (DDL.US) made a New York IPO in 2021.

That said, we’ll take a deeper dive into Freshippo to see how it stacks up against its rivals, including both Dingdong and more traditional chains, in China’s huge but also highly competitive grocery market.

In fact, China’s grocery market isn’t all that different from major developed countries, with most chains posting extremely thin profit margins on huge but slow-growing sales, resulting in extremely low price-to-sales (P/S) ratios for their stocks. Leading Chinese players Sun Art (6808.HK), operator of the RT-Mart chain, and Yonghui (601933.SH) are typical of the group, with P/S ratios of 0.21 and 0.34, respectively. Leading U.S. operator Kroger (KR.US) is similar, with a P/S ratio of 0.23.

A similar ratio of about 0.25 would give Freshippo a market value of about 15 billion yuan ($2.1 billion), based on the company’s 61 billion yuan in sales last year reported by the China Chain Store & Franchise Association. That sales figure made Freshippo China’s sixth largest supermarket chain last year, as it officially entered the top 10 for the first time, according to the association.

Freshippo would certainly like investors to think it has something fresh to offer from the other traditional retailers, and thus it should get a higher ratio. But even Dingdong, which has emerged as China’s leading online grocer, has a current P/S ratio of just 0.22 despite posting 20% revenue growth last year – well above the low single-digit growth posted by Yonghui and Sun Art.

What’s so special?

With those basic financials as background, we’ll spend the second half of our review taking a closer look at why Freshippo thinks it’s special and deserves extra investor attention. The company does have a few relatively unique features that set it apart from the others, though it’s unclear if any of those will result in the kinds of fatter profit margins that would justify a higher valuation. We’ll have to wait for the company to file its first IPO prospectus, most likely sometime this year, before we can judge just how much better or worse it’s faring compared with its peers.

The company’s biggest distinguishing factor is probably its strong focus on online sales, which complement traditional offline shopping at its brick-and-mortar stores. That results in much bigger shopping volumes at each of its stores compared with its peers. Our calculations show that each Freshippo generated about 200 million yuan in sales last year, compared with about 150 million yuan for Sun Art, whose stores are generally larger, and just 90 million yuan for Yonghui.

Such higher sales volume per store is generally a sign of greater efficiency, which could result in higher gross margins for Freshippo. But that said, one reason Freshippo can handle such high online order volumes is because it’s the only major chain to operate its own delivery fleet. That’s generally more expensive and less cost-effective than the third-party delivery companies used by its peers.

Freshippo is also distinguished by its heavy additional focus on on-premises dining and prepared foods. The presence of big food courts in most of its shops, together with the chain’s big focus on prepared foods, both cater to the kinds of less price-sensitive young people that Freshippo sees as its core customer base. Such products also tend to carry much higher profit margins than those for simply selling traditional supermarket products.

As a young chain, Freshippo also offers better growth potential since it’s still relatively small. And its two-pronged strategy of operating more traditional-style supermarkets, together with its Freshippo Outlets budget brand, gives it a bit more format flexibility to fit local demographics and spending patterns. The Freshippo Outlets chain is still relatively small with just 68 stores, meaning there’s also more room for growth for that format.

At the end of the day, we honestly can’t get too excited about Freshippo, mostly because it’s in such a mature industry with such low profit margins. Still, the company does have some unique features that could make it one of the more attractive new options for anyone looking to invest in this low-growth space. Now, we just need to see some more detailed financials.

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