Online grocer’s shares rally after it announces signing up hundreds of new direct suppliers, even as its margins remain far below those of larger rival Dingdong

Key takeaways:

•      Online grocer Missfresh said it expanded its network of direct suppliers, aiming to improve margins that lag far below larger rival Dingdong

•      Direct sourcing could help company lower procurement costs as it struggles to turn a profit

By Warren Yang

In its short life as a public company, Missfresh Ltd. (MF.US) has learned the hard way that it’s not easy to win over investors as a loss-maker in China’s fiercely competitive online grocery market. Now, in an effort that shareholders seem likely to appreciate, it is stepping up its game to cut more fat from its supply chain.

The company, which went public in June, said Thursday that it will directly procure products from 200 more farms, as well as 350 factories and processing facilities across the country. Even before adding those new suppliers, the company sourced more than 90% of its fresh produce and 80% of all products directly from their origins, much higher than an industry average of 55% for last year. Missfresh is aiming to continuously boost these ratios.

On the surface, an expansion of an already-large direct supplier network doesn’t seem like the most exciting news. But Missfresh’s stock rose 9% in two days after the announcement, giving it a much-needed lift in its difficult drive to land its stock in investors’ shopping carts. Still, the stock is a huge laggard compared to larger rival Dingdong (DDL.US), whose overall growth and performance metrics far outshine the smaller Missfresh.

There are a couple of simple reasons why investors apparently liked Missresh’s latest announcement of boosting its direct purchasing.

From a profitability perspective, direct sourcing helps the company improve margins by eliminating costly middlemen. It also enables Missfresh to get fruits, vegetables and other produce into the hands of its customers more quickly and keep the products fresher – a key attraction for shoppers that can translate into more sales.

Better margins are precisely what Missfresh needs as the 7-year-old company searches for profits – something it has yet to find even though it and its rivals have been growing fast in terms of revenue. That rapid growth is coming from legions of Chinese who are rapidly abandoning traditional wet markets and even a newer generation of supermarkets in favor of the convenience of buying groceries online – often for delivery within an hour.

Missfresh and its other money-losing rivals are all grappling with various costs that vastly exceed revenue. For starters, the company has a high cost of revenue, which includes procurement costs, squeezing its gross profit margin.

In the two years through 2019, Missfresh’s gross profit margin was less than 9%, a dismal figure for a grocery retailer, especially an online one that should theoretically benefit from the absence of high costs associated with brick-and-mortar stores. By comparison, Walmart (WMT.US) had a gross profit margin of about 25% last year, even though the U.S. retail giant operates an extensive network of brick-and-mortar stores in addition to an online platform. 

Missfresh’s gross profit margin briefly shot up last year. But that was an aberration that owed largely to an unusual spike in sales in the first half of the year when China’s Covid-19 outbreak kept people home and forced many to shop online. In its most recent reporting quarter through June this year, the margin not only fell back but also sank below pre-pandemic levels as the company offered more discounts and coupons to entice shoppers.

Centralized Business Model

Missfresh is also at a relative disadvantage to some of its rivals like Pinduoduo (PDD.US) and Meituan (3690.HK) because its business model includes fundamental features that bring very high operating expenses. After buying products at their origins, Missfresh uses cold chain transport to get them to city sorting centers. From there the goods go to smaller local warehouses, which are responsible for filling actual customer orders.

The centralized model allows Missfresh to tightly control quality, but requires a lot of money to operate. Missfresh categorizes costs associated with product delivery, warehouse operation and quality control as “fulfillment expenses,” which collectively accounted for about a third of its operating expenses in the second quarter – the largest single part of its operating expenses.

The company passes those costs to consumers, which limits its customer base to higher-end buyers who can afford its relatively high prices. By comparison, rival services operated by Alibaba (BABA.US; 9988.HK), Meituan and Pinduoduo, which entered the market later than Missfresh, use third-party suppliers and warehouse operators to keep costs down and limit their need for capital. That allows them to offer lower prices for shoppers, though they have less control over quality. 

Like Missfresh,Dingdong has a model of directly operating its network and is also unprofitable. But revenue at Dingdong increased at nearly double the pace for Missfresh in the second quarter, as the former boosted its lead over its older rival. Dingdong also held its gross profit margin at about 15% for the quarter, not particularly impressive but double the 7.5% that Missfresh reported for the three-month period.

Unlike Missfresh, Dingdong does not disclose the proportion its direct purchases make up of its total procurements. Dingdong’s higher gross profit margin may owe partly to its larger network of direct suppliers, its better bargaining power due to its larger size, or both. 

As such, investors seeking a piece of China’s online grocery market are gravitating toward Dingdong, which went public around the same time in late June as Missfresh. Dingdong’s shares were about 20% higher than its IPO price at the close of trading on Monday, a lofty accomplishment when one considers that most U.S.-traded Chinese stocks have dropped sharply over that period due to regulatory uncertainties at home.

By comparison, Missfresh’s stock has lost more than two-thirds of its value since its market debut. Dingdong has a price-to-sales (P/S) ratio of about 4, based on 2020 revenue, compared Missfresh’s multiple of less than 1. 

To play catchup to Dingdong, Missfresh could go about improving its margins in a number of ways. For example, it could try to increase offerings of more profitable goods, such as premium private label products, and improve operational efficiency for its warehouses through technological enhancements.

As things stand now, achieving profitability seems like a stretch for Missfresh, and it could become even more difficult as competition intensifies. None of the analyst estimates compiled by Yahoo Finance project either Missfresh or Dingdong will become profitable this year or next. Still, the further elimination of middlemen in Missfresh’s supply chain shows the company is trying to make its costly operations as lean as possible.

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