Meituan: Optimistic Prospects But Significant Risks (OTCPK:MPNGF)

Chinese food delivery giant Meituan (OTCPK:MPNGF) continues to deliver strong growth despite being adversely impacted by headwinds to its travel business as a result of China’s zero-covid strategy. With China lifting these restrictions, Meituan is positioned to benefit near term from pent-up travel demand. Long term prospects for both of Meituan’s key business segments are positive but their new initiatives are likely to remain a drag on profits. Competitive risks are also significant.

Strong growth momentum, swings back to the black

Chinese food delivery giant Meituan has been growing at a solid pace. Revenues have grown consistently at double digits over the past several years.

The momentum has continued this year with revenues growing at double digits and ending seven straight quarters of losses, Meituan turned a profit of CNY 1.2 billion for Q3 2022 (quarter ended September 2022) despite China’s ‘zero covid’ policy impacting its OTA business.

Looking ahead…

China’s food delivery market has ample room for growth

With around 544 million users, China’s food delivery market is quite mature with a penetration rate of around 52%. However there is still some room for growth in user numbers. Delivery dynamics means food delivery tends to be focused on dense, urban areas rather than rural ones. China’s urbanization rate currently stands at around 64% (equating to more than 850 million urban residents), nearly reaching its 65% target in its 14th Five Year Plan (2021-2025), but still lower than countries such as the Netherlands (93%), United States (83%), Germany (78%), and Russia (75%) to name a few. China’s continuing urbanization efforts is a positive trend for food delivery.

The bigger opportunity for market expansion lies in increasing order values. With a per capita income that is nearly six times smaller than countries such as the U.S., average online food order values are also considerably smaller ($8 for China’s Meituan, versus $30 for American food delivery player DoorDash) (DASH) suggesting tremendous opportunity for long term growth.

Macquarie Research

Macquarie Research predicts China’s food delivery market will grow at double digit rates over the next few years, and Meituan as the market leader (Meituan is China’s biggest food delivery platform with a market share of around 67% followed by Alibaba’s Ele.me (BABA) with 27%) is poised to benefit.

Macquarie Research

In-store, hotel & travel – cautiously optimistic short term prospects thanks to China’s re-opening, long term prospects intact

In-store hotel & travel, Meituan’s most profitable segment, has suffered due to lockdowns under China’s strict zero-covid policy but nevertheless the segment still managed to deliver growth thanks to continued expansion of its ecosystem of consumer services, and greater rural penetration among other efforts. The segment reported profits of CNY 14 billion in 2021, 66% higher than in pre-pandemic year 2019 when the segment’s profits were CNY 8.4 billion.

With Beijing ending their zero-covid policy early this month (resulting in an easing of domestic travel restrictions), travel demand has reportedly spiked as travelers eagerly made travel arrangements for the upcoming Chinese New Year festivities in late January. The trend is a near term positive for Meituan whose competitive advantage in lower-tier markets and lower star hotels positions it to benefit from a recovery in domestic travel, provided China does not re-impose fresh lockdowns.

Long term, the segment’s revenue potential is intact. As one of China’s leading online travel agencies Meituan is positioned to benefit from China’s travel market which offers enormous room for growth; less than 10% of China’s one billion plus citizens have passports (compared with about 44% in the U.S.) and with incomes just about a sixth that of the U.S., rising incomes should boost long term travel demand.

Moreover, helped by the Chinese government’s rural revitalization efforts, domestic travel and ‘rural tourism’ is on the rise, a positive trend for Meituan who dominates China’s lower tier markets and lower star hotels while archrival Trip.com is dominant in upper tier markets and higher star hotels.

Strategically, Meituan is expanding its presence towards higher tier markets and higher star hotels, as well as diversifying their product offering for instance by including theme parks etc to offer better travel package deals as well as expand cross-selling opportunities. Not only does this expand Meituan’s addressable market, but could potentially be margin accretive as well, since higher star hotels generally command a more affluent customer base.

New initiatives likely to remain a revenue driver but unprofitable

Meituan’s New Initiatives segment is the company’s fastest growing business segment (revenues rose 146% between 2019 and 2021, versus 75% for food delivery and 46% for pandemic-impacted In-store, hotel & travel), but is also a massive drag on profits with the segment’s losses of CNY 38.4 billion in 2021 far exceeding the CNY 21 billion generated by Meituan’s two profitable segments (Food Delivery and In Store, Hotel & Travel).

Although this segment continues to burn cash, longer term, the effort could improve competitiveness; these new services strengthen network effects and contribute to expanding the platform’s consumer services ecosystem, which not only provides cross-selling opportunities but also provides customer data to better serve merchants in their marketing and advertising efforts on Meituan’s platform

Financially, New Initiatives is likely to remain unprofitable in the foreseeable future. Meituan’s group buying service – Meituan Select (the largest business within its New Initiatives segment) largely caters to consumers in lower tier cities (users in tier-3 cities and lower account for 62% of Meituan Select’s userbase). Although they tend to be more receptive to group buying services, they are a relatively challenging customer base to monetize given their relatively limited spending power. For perspective, JD.com (whose tier-3 and lower account for about 52% of their userbase and whose group buying business targets high end consumers in top-tier cities), has tried and failed a few times to get its group buying business off the ground.

Meituan Grocery, Meituan’s online grocery business positions the company to capitalize on China’s booming online grocery market which has been growing at a scorching pace since 2020 is forecast to grow at double digit rates annually over the next few years.

Online grocery, however, is also generally financially challenging as a business if more established players such as Instacart (founded in 2012) and DoorDash (founded 2013 versus Meituan Grocery which launched in 2019) are anything to go by; DoorDash is loss-making and Instacart which cut its valuation thrice only recently turned profitable, despite these players competing in the U.S., where incomes are considerably higher than China. However, Meituan’s efforts to improve operational efficiency including improving supply chain and logistics capabilities could help control losses.

Risks

Regulatory risks

Meituan, like its fellow domestic tech rivals, has been subject to penalties as well as other forms of regulatory pressure from Beijing. Major shareholder Tencent (OTCPK:TCEHY) reduced its stake in Meituan as part of its effort to shrink its portfolio of tech investments, and Tencent-investor Naspers is reportedly looking at offloading the Meituan shares it received from Tencent.

Although China’s regulatory crackdown is expected to ease, the possibility of further regulatory scrutiny cannot be ruled out.

Possible margin pressure from public criticism and regulatory pressure to improve rider working conditions

In response to public criticism and the Chinese government’s move to tighten regulations around riders’ working conditions last year, Meituan vowed to improve working conditions and wages for their riders. Although margins have held up so far (partly by reducing discounts and promotions offered to customers), the possibility of stricter regulations and therefore margin pressures cannot be ruled out.

Competitive risks

Arguably, one of the biggest risks facing Meituan is competition. In food delivery, Alibaba’s Ele.me is ramping up efforts to gain market share (in August this year the company tied up with short video behemoth Douyin enabling Douyin viewers to directly order food from Ele.me), and in the OTA segment, Trip.com (TRIP) is encroaching into Meituan’s core lower-tier cities. Meanwhile Alibaba’s online travel arm – Fliggy – which saw an 800% increase in overseas flight searches in the last week of December – is busy working to counter Meituan’s rising dominance in China’s consumer internet landscape. Alibaba has a tremendous advantage not just in terms of finances, but also with its massive userbase – its lifestyle app Alipay boasts 1.3 billion active users versus less than 700 million for Meituan.

Group buying is already a crowded market with all tech giants including Alibaba, Tencent, Pinduoduo (PDD), JD.com (JD), and Didi.com (OTCPK:DIDIY) vying for a share of the market which had around 285 players early this year. All these players are also competing in the online grocery space, which may also see more competition in the future from traditional grocers launching their own online grocery services to preserve margins and gain customer data, a trend already playing out in the west with grocers such as Walmart (WMT) and Kroger (KR) venturing into the online grocery space themselves. Irrational competition could possibly lead to steep losses for Meituan.

Conclusion

Meituan has so far generated strong growth despite its profitable OTA business being impacted by China’s zero covid policy. With China lifting covid restrictions, Meituan should benefit from pent-up travel demand near term. Longer term, Meituan’s biggest businesses – food delivery, and in-store, hotel & travel, in which Meituan enjoys market leading positions, are positioned to benefit from structural growth drivers which should help drive top line and bottom line growth as well. Meituan’s New Initiatives (which includes challenging businesses such as group buying and online grocery) are likely to remain a drag on profits for the foreseeable future however strategically they could enhance competitiveness and efforts to improve operational efficiency can keep costs under control. Competitive risks however are significant. Meituan may be a buy for investors with a high risk appetite but not so for risk averse investors.

Analysts are very bullish on the stock.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.