Its 10-year plan dying on the vine, what went wrong at Pagoda?

The fruit giant’s shares have crashed this year as it and its food and beverage peers get shunned by China’s increasingly frugal consumers 

Key Takeaways:

• Pagoda’s profit for the first half of this year plunged by nearly 70%
• The fruit seller’s number of franchised stores at the end of June also decreased by 70 from six months earlier

By Lau Chi Hang

Shenzhen Pagoda Industrial (Group) Corp. Ltd. (2411.HK) thought it was king of the vine when it announced an ambitious 10-Year Plan at the start of this year, proclaiming its aim “to become a global fruit king with its world-leading quality fruits.” But rather than tempting investors with such sweet talk, the stock has been dragged into the dirt this year, falling more than 70% from its high at the start of 2024.

Some initially pinned the plunge on massive one-time selling at the end of a lockup period after Pagoda’s January 2023 IPO. But the big rush for the exits begs the question of why such longtime shareholders suddenly lost their appetite for the company.

Signs of trouble emerged when the company issued a profit warning last month. Now, its full interim report for the first six months of the year is showing just how bad things are at one of China’s leading fruit sellers. The company said its profit plunged 66% to just 88.5 million yuan ($12.4 million) year-on-year in the first half of 2024, as its revenue fell 11% to 5.59 billion yuan.

Million-yuan stores no more

Pagoda’s business model is quite simple, relying on continuously adding franchisees, and then making money by selling them fruit. The concept is standard fare in the franchising world, where more franchisees and higher sales per store translates to higher revenue for the franchise owner.

Its latest report shows Pagoda had 6,011 franchised outlets by the end of June, up by 66 outlets year-on-year. But its total revenue from franchisees in the first half of the year fell by 15% year-on-year, showing more franchisees doesn’t necessarily translate to more revenue.

So, what happened? It turns out the average revenue for Pagoda’s franchised stores dropped 13.7% year-on-year to only 900,000 yuan during the latest six-month period, down from 1 million yuan a year earlier. The company blamed weak spending by Chinese consumers for the sales decline, echoing a similar refrain coming from other retailers.

At the same time, Pagoda’s franchised store count may be up year-on-year, but a closer look shows the number has actually dropped by 70 compared to its 6,081 stores at the end of 2023. Pagoda’s growth momentum has weakened steadily over the last two years. Its revenue rose about 10% to 11.31 billion yuan in 2022, then barely rose at all to 11.39 billion yuan last year.

Its stagnating sales and shrinking stores suggest there’s little hope that Pagoda will be able to complete even the first step in its 10-year plan, at least for now. In the current market where consumers are reining in their spending, Pagoda might be lucky simply to maintain its current store count, never mind growing its pool of franchisees. Things are only likely to worsen in the second half of this year, making life even more difficult for the fruit retailer.

Climbing expenses

While Pagoda’s revenue is falling, the same isn’t true for its expenses. Its administrative expenses increased by 14.9% in the first half of the year to 169 million yuan from 147 million yuan a year earlier after hiring more administrative staff. Its sales expenses also increased by 22% over that time as it conducted more promotions and marketing events.

In a slightly worrisome sign, Pagoda appears to be offsetting those increases by cutting its R&D spending. The company has reduced the size of its R&D team, allowing it to cut its related spending by 10.5% to 66.3 million yuan in the first half of the year. In the end, it’s saving a little bit of money. But such cuts to an area often considered key to a company’s future shouldn’t be reduced unless absolutely necessary, especially in today’s technology-driven world. 

Pagoda’s main business may be fruit, but it’s also quite fond of financial products. It spent 230 million yuan on such products from the Bank of Beijing in early July, then almost immediately spent another 175 million yuan on products from Citic Bank on July 4. There’s nothing wrong with using idle funds for short-term investments. But such moves could also reflect caution about its own prospects by failing to use the money to develop its own business. 

Reserved investors

In August last year, Pagoda announced that its Chairman and major shareholder Yu Huiyong and his wife Xu Yanlin pledged 3.7% of the company’s shares to Shanghai Pudong Bank as collateral for a 380 million yuan loan. The announcement didn’t explain the purpose of the loan. Then, just months later in January this year, Xu entered into a similar new agreement with the same bank. Such pledges often raise red flags for investors, who worry whether they reflect major shareholders’ personal financial problems that may affect the company.

What’s more, Pagoda executive deputy general manager Jiao Yue reduced his holdings in the company several times between May and June this year. According to stock exchange disclosures Jiao’s Pagoda holdings fell from 7.43% to 6.96%. over that time, as he cashed out 7.5 million shares for more than HK$22 million – hardly a positive sign for minority shareholders.

Pagoda applied to make all of its H-shares eligible for full circulation, and was just recently notified of the application’s acceptance by China’s securities regulator. The notice allows 300 million shares held by six of the company’s shareholders, accounting for 20.17% of its total issued share capital, to be publicly traded in the Hong Kong stock market. More available stock on the market will undoubtedly put more pressure on the share price.

It’s probably still too early to say whether Pagoda will ever realize its dream of becoming a global fruit king in 10 years as founder Yu is hoping. Meantime, investors will be watching closely to see if the expiration of a new one-year lock-up period for several major shareholders set to expire in April next year may trigger a new round of massive selling.

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