In this round of Hong Kong stock market rally, $MEITUAN-W (03690.HK)$ becoming a bull market rider, the stock price doubled at one point in the past month, with a much higher increase than other internet-related stocks, for example, during the same period, $TENCENT (00700.HK)$ only rose by 30%, $BABA-W (09988.HK)$ rose by 40%, $JD-SW (09618.HK)$ Hitting a high of 80%; Meituan's performance in this round is obviously different from before, looking back at the 3 small rallies of HK stocks in the past year, Meituan usually has a similar growth rate to Tencent.

The recent surge is due to the mention of "Meituan defends against Douyin successfully, and the ghost story of Pinduoduo has just begun". Meituan and Douyin both focused on monetization in Q2, emphasizing business profit margins, with expectations of profit margin increases this year; another reason is that there is a big expectation gap in Meituan's profit space, but this has not been discussed in detail yet. Combining the recent surge, let's take a look at Meituan's growth potential in the next stage and why foreign investments are placing Meituan in an important position in this round.

First, what are foreign investors looking at?

In this round of big gains, Meituan is the most watched internet stock by foreign investors for a simple reason: there were too many expectation gaps for Meituan before, and concerns about the ghost stories, affecting the valuation. Now that the ghost stories about Douyin have faded and with the macro policies in force, Meituan has experienced a significant valuation correction wave, with a clear change in market funds' risk appetite.

Looking at the valuation, before this round of rise, Meituan was roughly around 800 billion, with the market expecting profits of 60 billion next year, equivalent to around 13 times PE. Now, Meituan's market cap has reached 1 trillion Hong Kong dollars, corresponding to around 16-17 times PE next year, bringing Meituan's valuation back to a high point in the past two years. Similarly, Tencent's market cap has returned to nearly 3.8 trillion Hong Kong dollars, with a valuation returning to a level of 18 times PE. Will we see even higher valuations in the future?

There are two reasons for Meituan's rapid rise: first, in the macroeconomic recovery situation where the denominator is rising, all stocks in the market are rising, not driven by the EPS profit growth of the numerator. Initially, it may have been raising the entire market's valuation, for example, Meituan and Tencent in this round of market at one point returned to over 20 times PE, but later when the market rationalizes, funds will still prioritize assets with EPS profit growth, such as Meituan and Tencent, which have seen significant inflows from large funds.

Secondly, as mentioned before, the positioning of various internet stocks has changed, and in the future, the competitive landscape for Meituan will be one of the internet stocks with higher certainty or less competitive pressure. From the perspective of the competitive landscape, foreign investors are focusing on Meituan's profit space after, which is also the largest expectation gap for valuation.

The positioning change of internet stocks, for example, those leaning towards stable growth will buy Tencent, with an annual probability of around 3-5% of direct shareholder returns, large buybacks supporting the stock price, along with a conservative estimate of 8-10% performance growth, Tencent is a very stable choice; for investors buying shareholder returns, that would be buying Alibaba and JD.com, which are mainly in passive defense, but with plenty of cash on hand for repurchases. This year, both companies' direct shareholder returns exceed 10%, as long as the core business successfully defends its position, maintaining growth within 0-1% will be considered successful. Meituan is still a growth-oriented company among internet stocks, so funds that opt for growth and stock price elasticity will choose Meituan.

Second, the expected gap of Xiaoxiang Supermarket.

Returning to the Meituan business, by the second quarter, Meituan and Douyin have found the profit margin. Meituan's in-store business profit margin has returned to the high level of 35%, which was the main catalyst for the recent stock price increase. The threat of Douyin to Meituan is not as exaggerated as rumored. Douyin has abandoned betting on takeout. Both parties are inclined to make money first, protect profits, which is a very good signal.

Another catalyst is the reduction of losses in Meituan's new business.

Meituan's second quarter new business revenue was 21.6 billion yuan, with a growth rate of 29%, exceeding the market's expected 20.5 billion yuan. This was mainly contributed by the strong growth of Xiaoxiang Supermarket. The new business only lost 1.3 billion yuan this quarter, less than the market's expected loss of 2.1 billion yuan; the new business had a loss of 2.8 billion yuan in the first quarter, which was reduced to 1.3 billion yuan in the second quarter. The management's guidance that the full-year new business loss will narrow to around 10 billion yuan has probably been achieved, and there is even a chance to challenge an annual loss of only 6-7 billion yuan. If the second half of the year's reduction in losses goes smoothly, it will greatly improve Meituan's profit expectations.

It is worth noting that Xiaoxiang Supermarket is currently the most controversial point in the market. If you are bullish on Xiaoxiang Supermarket, you can give Meituan a higher valuation space, for example, in the second quarter, Xiaoxiang Supermarket's reduction in losses exceeded expectations; if you are not optimistic about Xiaoxiang Supermarket, on the contrary, the new business is still a burden for Meituan, and this part of the business should not be valued.

Under macro improvements, there is no need to be too pessimistic, it might be worth considering what will happen after Xiaoxiang Supermarket?

When the market values Meituan, it usually excludes Xiaoxiang Supermarket, just like Pinduoduo does not include Temu in the valuation. Considering certain risk factors, a conservative valuation method is adopted. However, seeing the second-quarter reports of Meituan and Dingdong Buy, the pre-positioning model has begun to work, which is an important signal.

Currently, the market's view is that Xiaoxiang Supermarket may be profitable on the delivery side, after all, delivery is Meituan's core, but Xiaoxiang Supermarket's overall business is still in deficit.

From the user's perspective, when a user places an order at Xiaoxiang Supermarket and it is delivered, the model is that the delivery driver picks up the goods at the front warehouse and then delivers them to the destination. It seems similar to food delivery. If delivery alone is profitable, it should work; otherwise, both delivery and costs will be at a loss, and Meituan will not be able to reduce losses so quickly.

The key to the front warehouse model lies in the product procurement process. To simplify, whether Xiaoxiang Supermarket, Dingdong Maicai, etc., can procure products at a price better than other competitors and offer good quality products for users to choose from, enabling users to repurchase continuously. This is the key point of the front warehouse, which demands higher customer stickiness and average order value. It is not like food delivery where running more orders at Xiaoxiang Supermarket can reduce costs. The retail ability is the most important aspect to consider.

Compared to the offline supermarket model, considering that the front warehouse incurs delivery, personnel, and storage costs, under the same sales volume, the front warehouse model needs the average order value to be higher than that of offline supermarkets in order to be profitable. Having fewer orders does not affect it as much. The main focus is on the average order value per transaction.

Otherwise, under the same sales volume, even if the front warehouse's store costs are lower than offline supermarkets, considering the same sales volume, lower average order value, and increased delivery costs, the actual profitability of the front warehouse is not as good as that of offline supermarkets. For example, in 2020, the average order value of Dingdong Maicai was approximately between 40-50 yuan. In 2021, it increased to 52 yuan, and by 2023 when Dingdong Maicai switched from a loss to profit in terms of non-GAAP measures, the average order value rose to 72 yuan.

It proves that the profit model of the front warehouse can only be successful when the average order value increases. Dingdong Maicai's main customer base is users from first and second-tier cities who are not very price-sensitive and are willing to pay for groceries delivered to their homes.

Due to the unsatisfactory performance of Meituan Optimal before, and the relatively slow adjustment in efficiency, even after one or two years of adjustment, the market is currently not optimistic about Meituan's ability to curate products and control costs effectively at Xiaoxiang Supermarket.

The usual pessimistic view about Xiaoxiang Supermarket is that similar businesses like Dingdong Maicai, Hema, and even Sam's Club, Costco, have a higher level of maturity compared to Meituan. Xiaoxiang Supermarket seems more like a hybrid within an app, overlapping business functions with Meituan Optimal. It's not a direct app like others. Furthermore, competitors include local front warehouses in various cities, such as Pupu Supermarket, or even Yonghui Superstores after the acquisition of Miniso.

It can be said that the competition has been fierce in the past two years for front warehouses. It is a challenge to stand out among this fierce competition.

However, at the same time, Meituan has temporary weaknesses, and definitely has its own strengths.

Compared to Dingdong, Hema, Sam's Club, and the local front-end warehouse supermarket Pop Mart, Meituan's advantage lies in low customer acquisition costs, strong user stickiness of the Meituan app, just like when facing competition from Douyin in offline business, users also cannot do without Meituan.

Of course, offline business and front-end warehouse supermarkets cannot be directly compared. Going back to the aforementioned, the two key points of the front-end warehouse are, firstly, purchasing high-quality products, such as the products selected in Xiaoxiang Supermarket may be OEM sourced by Meituan from a third party. If the reputation of these products can be established, there is actually room for a premium on the products. Secondly, high-quality users who can afford a high average spending, strong user stickiness. Only then can the front-end warehouse's profit model run effectively.

An even more important point is that although the competition in the front-end warehouse model is fierce, there has not been a player with a relatively large scale and a significant market share. In fact, in the future, there may be a round of mergers and acquisitions in the front-end warehouse model. For example, players like the local front-end warehouse supermarket Pop Mart find it difficult to expand nationally. At most, they can only establish a presence in individual cities, but expanding nationwide is quite challenging and their scale is not that large.

Conclusion

In general, the market's lack of confidence in Xiaoxiang Supermarket is justified, but one should not underestimate Meituan's execution ability, especially against the backdrop of foreign capital inflows. As risk appetite changes, the market's previous strict valuation has also become more optimistic with foreign capital now willing to offer a more positive valuation.

Based on Meituan's delivery advantages, low customer acquisition costs, strong user stickiness, personally, I lean towards Meituan's ability to excel with Xiaoxiang Supermarket. If Meituan can do well with its new businesses like Xiaoxiang Supermarket, Flash Purchase, and Youxuan in the future, these three businesses will have significant profit contribution potential. In the medium to long term, Meituan has many areas where profit growth can be enhanced.

Editor/Somer