I assign a Neutral rating to Hong Kong-listed Chinese food delivery services company Meituan (OTCPK:MPNGF) [3690:HK], which was formerly known as Meituan Dianping prior to the change in company name starting from September 30, 2020.
The key factors driving Meituan’s recent share price outperformance are possible inclusion in the Hang Seng Index, the company’s domestic focus, and its better-than-expected 2Q 2020 results. All eyes are also on Meituan’s competition in the various businesses it operates in, and the amount of investments the company is making for its new initiatives business.
Meituan trades at consensus forward FY 2021 Enterprise Value-to-Revenue and P/E multiples (based on sell-side analysts’ estimates of normalized earnings) of 89.8 times and 8.5 times, respectively. I think that near-term positives such as potential inclusion in the Hang Seng Index, 2Q 2020 results and expectations of favorable domestic policies to boost consumption have largely been priced in. As such, I see a Neutral rating for Meituan as fair.
Readers have the option of trading in Meituan shares listed either on the Over-The-Counter Bulletin Board/OTCBB as ADRs with the ticker MPNGF, or on the Hong Kong Stock Exchange with the ticker 3690:HK. For those shares listed as ADRs on the OTCBB, note that liquidity is low and bid/ask spreads are wide.
For those shares listed in Hong Kong, there are limited risks associated with buying or selling the shares in terms of trade execution, given that the Hong Kong Stock Exchange is one of the major stock exchanges that is internationally recognized, and there is sufficient trading liquidity. Average daily trading value for the past three months exceeds $700 million, and market capitalization is above $200 billion, which is comparable to the majority of stocks traded on the US stock exchanges.
Institutional investors which own Meituan shares listed in Hong Kong include The Vanguard Group, BlackRock, Capital Research Global Investors, Schroder Investment Management, and Geode Capital Management, among others. Investors can invest in key Asian stock markets either using U.S. brokers with international coverage such as Interactive Brokers and Fidelity, or international brokers with Asian coverage like Hong Kong’s Monex Boom Securities and Singapore’s OCBC Securities.
Meituan used to be two separate companies, Meituan Corporation (focused on food delivery) and Dianping Holdings (focused on reviews of food and beverage establishments), which were started in 2010 and 2003, respectively. Meituan Corporation and Dianping Holdings merged in 2015 to form Meituan Dianping which was listed on the Hong Kong Stock Exchange in September 2018, and the company was recently renamed as Meituan as highlighted above. Internet giant Tencent (OTCPK:TCEHY) (OTCPK:TCTZF) [700:HK] is Meituan’s largest shareholder with a 20% stake.
The company is the largest food delivery services company in China, but it has diversified beyond its core business. The company’s in-store, hotel & travel business segment offers “in-store dining, hotel and travel booking, beauty, wedding planning and a variety of other lifestyle services”, as per its IPO prospectus. Meituan’s new initiatives & others business segment, as the name suggests, includes the company’s new businesses in online grocery retail, ride-hailing, bike-sharing, non-food delivery services, amongst many others.
Meituan derived approximately 59%, 18% and 23% of its 1H 2020 revenue from its core food delivery business, its in-store, hotel & travel business, and its new initiatives & others business, respectively. Excluding the loss-making (at the operating profit level) in-store, hotel & travel business and other non-cash & non-core items, the food delivery business and the in-store, hotel & travel business accounted for 40% and 60% of the company’s operating profit, respectively, in the fist half of the year.
Share Price Outperformance
Meituan’s share price has significantly outperformed the Hong Kong benchmark Hang Seng Index this year. Year-to-date, Meituan’s share price is up +183%, while the Hang Seng Index is down -13%. In the past three months, Meituan’s share price has increased by +50%, while the Hang Seng Index is flat over the same period.
I see Meituan’s recent share price outperformance driven by a number of factors as outlined below.
Firstly, certain investors view Meituan as an event-driven trade, as they think that the probability of Meituan being included in the Hang Seng Index is high.
On October 5, 2020, it was announced that the results of the quarterly review of the Hang Seng Family of Indexes, including the Hang Seng Index, for the third quarter of 2020, will be disclosed on November 13, 2020. The actual changes to the constituents of the Hang Seng Family of Indexes will be made starting on December 7, 2020.
In a publication discussing the Hang Seng Index published by Hang Seng Indexes Company Limited, the Hang Seng Index is referred to as “a market benchmark that reflects the overall performance of the Hong Kong stock market” which “measures the performance of the largest and most liquid companies listed in Hong Kong.” A listed company is eligible for consideration to be selected as one of the constituents of the Hang Seng Index (50 stocks), if it is in the top 90% of Hong Kong-listed companies in terms of market value and turnover, and fulfills the listing history requirement below.
Hang Seng Index’s Listing History Requirement For Eligibility Of Inclusion (MV refers to Market Value)
Meituan already meets the eligibility criteria for inclusion into the Hang Seng Index. Based on my research, Meituan has the third largest market capitalization and the third highest three-month average daily trading value among Hong Kong-listed stocks, only trailing behind Tencent and Alibaba (BABA) [9988:HK]. Nevertheless, there are also other factors such as “representation of the relevant sub-sector within the HSI (Hang Seng Index) directly reflecting that of the market” and “financial performance”, which the Advisory Committee considers in making the final decision on the constituents of the Hang Seng Index.
Notably, Meituan was among the favorites to be included in the Hang Seng Index after the 2Q 2020 review, but that did not materialize. On September 7, 2020, Meituan became a new constituent of the Hang Seng China Enterprises Index, but did not join the Hang Seng Index. If and when Meituan is included in the Hang Seng index, benchmark-hugging investors and institutions are likely to drive Meituan’s share price up as they acquire the company’s shares.
Secondly, Meituan is perceived as a “defensive stock” due to its domestic focus.
China is placing an increasing emphasis on the domestic economy, due to tensions with the US and certain other countries, and also the need to counter the economic fallout brought about by COVID-19. Reuters reported on September 16, 2020 that “China will rely mainly on ‘internal circulation’ – the domestic cycle of production, distribution, and consumption – for its development”; the term ‘internal circulation’ was mentioned by the Chinese president in May. In an October 9, 2020 article, ING research noted that “the source of growth for internal circulation is domestic demand from domestic consumption” and “policies are planned to boost internal circulation.”
At the same time, Chinese companies, especially those in the technology sector with overseas business operations such as Huawei and Tencent, have been a target of US sanctions, bans and restrictions in recent times. In contrast, Meituan is less likely to be a target because of its focus on the Chinese domestic economy.
In other words, Meituan is seen as a “safer bet” amongst the Chinese mega-companies, as it is a beneficiary of China’s policies to boost domestic consumption, and it does not have overseas businesses or any technological capabilities which could be possibly viewed as a threat to US national security.
Thirdly, Meituan beat market expectations with its 2Q 2020 financial results announced on August 21, 2020. The company’s top line increased by +47.6% QoQ and +8.9% YoY to RMB24,722 million in 2Q 2020, while its headline net profit reversed from a loss of -RMB1,579 million in 1Q 2020 to positive earnings of RMB2,210 million in 2Q 2020, and this represented a +152% YoY increase as compared to 2Q 2019. Meituan’s adjusted net profit (the company’s own internal measure adjusting for non-cash and non-operating items) also grew +82% YoY from RMB1,494 million in 2Q 2019 to RMB2,178 million in 2Q 2020.
COVID-19 and associated lockdown measures in certain Chinese cities in the early part of the year have caused significant disruption to Meituan’s business operations as evidenced by its losses in 1Q 2020. But it is clear from the latest 2Q 2020 results that Meituan has recovered strongly, and it is back on the path of growth again.
All Eyes On Competition And Investments In New Initiatives
I think that there is little disagreement that Meituan operates in end-markets in China with strong growth potential in the medium to long term. But Meituan does face intense competition in its various business lines, and its continued investments in new initiatives and new businesses could continue to be a drag on the bottom line in the near-term with no guarantee of success in the future.
Using the food delivery business as an example, competition is intense. Meituan has a market share in excess of 60% for the Chinese food delivery services market, and its closest competitor is Ele.me with a market share close to 30%. Although Meituan is the pioneer and clear market leader in the food delivery market in China and Tencent is its largest shareholder, Ele.me is also backed by internet giant Alibaba.
Furthermore, there are always new entrants seeking to enter the delivery market. According to a March 16, 2020 Reuters article, Chinese ride-hailing platform operator launched its delivery services for coffee and groceries in 21 Chinese cities. Even if Meituan were to maintain its market leadership in the Chinese food delivery services market, it could possibly come at the expense of lower profitability in the form of reduced commission rates to be more competitive.
Separately, Meituan continues to invest in the loss-making new initiatives & others business segment, which suggests that losses could widen in the near-term. At the company’s 2Q 2020 earnings call on August 21, 2020, Meituan highlighted that “going forward, for example, we plan on setting up our investment in both grocery retail and e-bike.”
It is also notable that Meituan is a shareholder in electric vehicle maker Li Auto (LI), and one of the sell-side analysts at the recent 2Q 2020 earnings call asked about the “very little synergy” that Li Auto has “with existing Meituan businesses.” In response, Meituan emphasized that the company has a time horizon of “at least five years, 10 years, if not decades” with respect to its investment in Li Auto.
Meituan trades at consensus forward FY 2020 and FY 2021 P/E multiples (sell-side analysts’ estimates of normalized earnings) of 267.5 times and 89.8 times, based on its share price of HK$288.20 as of October 30, 2020.
The stock is also valued by the market at 12.8 times consensus forward FY 2020 Enterprise Value-to-Revenue and 8.5 times consensus forward FY 2021 Enterprise Value-to-Revenue.
The key risk factors for Meituan are a failure for the stock to be included in the Hang Seng Index at the next review, future domestic policies or regulations that have a negative impact on the businesses that the company is involved in, increased competition leading to either market share loss or lower profitability in the areas it competes in, and investing aggressively in new initiatives that do not create value for shareholder in the medium to long term.
Note that readers who choose to trade in Meituan shares listed as ADRs on the OTCBB (rather than shares listed in Hong Kong) could potentially suffer from lower liquidity and wider bid/ask spreads.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.