Dingdong: Bleak Growth Outlook Due To Competitive Pressure

seekingalpha07-09

Dingdong is recommended as a sell.DDL's business model may face challenges from weak macroeconomic conditions and increasing competition in the grocery delivery space.Given the poor outlook and ...

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Motortion/iStock via Getty ImagesInvestment summary My recommendation for Dingdong (NYSE:DDL) is a sell rating. I am not a fan of the competitive environment that DDL is competing in today. The two large competitors have a strong foothold in their core businesses, which gives them a constant stream of cash flow to reinvest in growth initiatives (like grocery delivery). The key competitor is Pinduoduo (PDD), which has shown great execution so far and is gradually replicating the DDL product offering. Therefore, I expect DDL to see weak growth ahead and will continue trading at a steep discount to peers. Business Overview DDL provides on-demand grocery delivery services to consumers. DDL works with upstream suppliers and purchases the majority of its products from direct sources. These products are then stored at a regional processing center before being transported to the designated frontline fulfillment centers (FFCs) based on AI-projected demand. From the consumer's end, they browse products on the Dingdong App or Mini Program and place their orders. The bull case for DDL is that because of its scale and close relationships with suppliers, it is able to provide a lower-cost service to consumers and also minimize inventory losses (remember, these goods have a short shelf life). However, I believe the DDL business model is not working as well as it should, and I believe business growth is going to see major headwinds from both the weak macro environment and heavy competition. Weak macro outlook   Trading EconomicsReaders who have briefly followed the Chinese economy will know that the economy is not doing as well as it was in the past after getting hit by both cyclical and structural factors. These have led to a slowdown in consumer spending, where consumer confidence is near an all-time low. Consequently, fast-moving consumer goods [FMCG] industry growth continues to be lackluster. While I am not a Chinese economy expert, my assessment of the situation is that consumer spending is a lot weaker than what the headlines are showing, as the reported figures (consumer confidence and spending, etc.) are weak despite the little-to-no inflation environment and government cutting rates. What I infer from all of this is that consumer demand is likely going to stay persistently weak in the near term. Heavy competition to structurally impair growth The bigger problem for DDL is that its competitors have become larger and have been gaining a relative share. Having scale and a large market share is important for a marketplace model like DDL because they need sufficient supply to attract demand (consumers), and for suppliers to want to partner with DDL, DDL needs to show that they have a sufficient consumer base. This flywheel effect works very well when DDL is growing. However, as you can see, it is a double-edged sword, as DDL will start to lose suppliers (less demand due to a lower number of consumers) and consumers (less supply as suppliers decide to end the partnership) when it begins to see negative growth. In the past, when consumer spending power was strong, the Chinese economy's growth outlook was positive, and competition was rather fragmented, it was easier for DDL to compete because none of these players had a substantial market share yet. However, things have changed (two big major players today with a larger market position than DDL), and I believe DDL is losing whatever lead it has garnered over the past few years, and it is going to see more competition headwinds ahead.   MomentumWorksThe key competitor that has managed to gather a significant size within a short period of time is PDD (Duoduo Maicai). PDD has managed to pivot from its original community group buy business to tap into the large grocery delivery space and win significant market share through strong execution. For comparison, PDD competed against prominent names that were backed by investors with deep pockets, and it started with the lowest GMV. In just 3 years, PDD managed to become the largest on-demand grocery delivery player in China and has continued to grow at a rapid rate over the past 5 quarters, while DDL’s GMV shrank by 16% over the LTM basis (vs. FY22).   Redfox Capital Ideas  Redfox Capital IdeasAside from PDD, we should not forget that Meituan (OTCPK:MPNGF) is another major player in the grocery delivery space (it will have a similar GMV size as PDD in 2023). The competitive position of DDL is structurally poorer than that of these two large players because both PDD and Meituan have a core business that they have a strong foothold in:  PDD's existing community group buy business had a run-rate GMV of ~$511 billion in 1Q24 and average daily orders of close to 200 million. Notably, this business is still showing very healthy growth, where GMV saw 18% as of 1Q24 and average daily orders grew 12% in FY23. Meituan core food delivery service had a run rate GMV of ~$130 billion in 1Q24 and is still growing at 18%.  This large and loyal customer base provides PDD and Meituan plenty of daily opportunities to cross-sell their grocery delivery services. Most importantly, these core businesses are profitable for PDD and Meituan, which can provide them with positive cash flow to reinvest in the grocery business and marketing (to solidify their consumer mind share). For reference, PDD reported a blended adj. EBIT margin of 33%, and the Meituan food delivery segment reported a segment EBIT of 16%. Whereas for DDL, despite the business slowing significantly (where it should also mean that DDL can reduce cost), blended adj EBIT margin is still barely profitable (0.2% as of 1Q24). The convergence of food delivery to other forms of delivery (grocery in this case) is a common trend in other parts of the world, and this makes sense because the underlying delivery infrastructure, consumer-facing app, and branding have already been built up. Offering groceries will simply increase the stickiness of the app, and as such, I don’t see PDD and Meituan leaving this space anytime soon. Meituan management even called out grocery as an important initiative for the company in the latest call: The first is, online grocery is very important for Meituan and second online grocery is very difficult to get right, but we are going to keep working on that. The pushback from bullish DDL investors is that DDL has a competitive advantage because it works directly with suppliers, and that should give it some form of cost advantage that can be shared with consumers. I don’t believe this is an advantage that is as strong as it seems. In the 1Q24 call, PDD management talked about how they have rolled out solutions to enable direct delivery of agricultural products from their place of origin (which I infer as suppliers). Additionally, PDD has just secured a license to operate last-mile delivery stations, further solidifying its delivery capabilities. The team at PDD has a strong track record of execution, and there is a good chance they will execute this really well too. If PDD is able to fully (or to a large extent) replicate the supplier base that DDL has (which I believe it could since PDD has an even larger customer base to convince these suppliers), I believe DDL will continue to lose market share. We have also innovated many agriculture solutions such as the direct delivery of agricultural products from the place of origin and our Duo Duo Grocery, building up a platform that connects local supply to local demand. PDD 1Q24 earnings transcript For those who do not believe DDL could continue to lose share because it had a head start vs. PDD, let me remind you that Missfresh, a pioneer in this space, collapsed because of strong competition. I am not saying DDL will become like Missfresh, but I expect DDL to see a lot of competition challenges ahead. Valuation Given the competitive pressure and weak economic outlook, I believe DDL growth is going to be lackluster in the coming quarters and years, and this headwind is only going to get larger as both PDD and Meituan continue to grow profitably. As such, I expect DDL to continue trading at a steep discount vs. these two peers (currently at 0.11x forward revenue vs. PDD at 2.31x and Meituan at 1.6x). Risk There are two upside risks: DDL will continue to show positive growth performance despite growing competitive pressure. The second upside risk is that DDL manages to drive margin expansion. This would send a message to the market that DDL could become a profitable growth business once the economy recovers (which will benefit DDL one way or another since consumer spending power is back). Given that DDL has been reporting poor margins so far, I expect this to drive some multiples upside. Conclusion My view for DDL is a sell rating because of its bleak growth outlook. The competitive landscape has shifted, with established players like PDD and Meituan leveraging their existing customer bases and profitability to aggressively expand into grocery delivery. This, coupled with a weak Chinese economy, will likely lead to sluggish growth for DDL. PDD is also gradually replicating DDL’s direct supplier model. Given the significant headwinds, I expect DDL to trade at a discount to its peers.  Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. 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