Why Venture Capitalists Like Expensive Groceries

(Bloomberg Opinion) -- Nobody likes a big grocery bill. Unless you're a venture capitalist, of course.

With the cost of produce skyrocketing in China, hot money is flooding toward fresh-food operators. Yonghui Superstores Co., a $14 billion firm that counts Tencent Holdings Ltd. as a strategic investor, now trades above 40 times 2019 earnings. Shares of Jiajiayue Group Co., a smaller supermarket chain, have done even better, soaring 47% so far this year.

Online grocers are also rising as the hot new consumer tech. In March, Yipin Fresh Produce raised 2 billion yuan ($290 million) in a funding round led by Tencent. In just seven months, venture capital-backed Ding Dong Groceries tripled the number of its distribution centers to 345. 

As food prices continue to climb, whoever can get groceries delivered cheaply and quickly will capture China's wallets (and stomachs), or so the thinking goes. 

Take a look at these mouth-watering numbers. In May, food inflation came in at 7.7%, a three-year high. Pork prices are rising with the swine fever epidemic, but fresh fruit is soaring, too – up 26.7% from a year ago. Buying an apple cost almost 20% more in May than it did a month earlier, and about 35% more than in 2018. Chinese netizens are joking that their financial goal this summer is to be able to afford a piece of fruit.

Of course, the government is blaming bad weather: A cold spring last year shrank the production of apples and pears, and this year's lychees are too sour. But the problem goes much deeper than that. Layers of grocery distribution, particularly for fresh produce, means there's a lot of fat to be trimmed. This helps explain why Yonghui – which gets 47% of its sales from such goods, the highest among its peers – is outperforming Sun Art Retail Group Ltd., backed by Alibaba Group Holding Ltd. 

Wet markets and neighborhood groceries are still an integral part of daily life in China, accounting for one-third of fresh produce sales. But poor sanitation and refrigeration create a lot of waste. Roughly 15% of fruit goes rotten and unsold, three times as much as developed nations, estimates Hua Chuang Securities Co. 

That's given e-grocery startups a chance to improve logistics with virtual wet markets. Ding Dong, for instance, sets up distribution centers within 1 kilometer (0.62 mile) of the neighborhoods they serve. Shoppers have come to expect delivery within 29 minutes – and even free scallions, an appreciative gesture commonly adopted at wet markets. And just like your local experience, Ding Dong will kill and clean live fish for you, with their intestines neatly packaged.

In theory, e-grocers have a path to profitability. Yonghui, for instance, eked out an operating margin of 1.2% in 2018. Startups like Ding Dong could consider opening up more distribution centers and expand their offerings to include dry goods. But they'll need to resist the temptation of growing too quickly as funding pours in. Ding Dong will run into trouble if its daily orders per center fall below 1,250 a day, warns Haitong Securities Co. During a recent visit to a local center, I saw dozens of bottles collecting dust on shelves. Fast turnover wasn't the word that came to mind.

In China, the most feared phrase isn't the trade war, or Donald Trump, but Japanification. People are worried the country's aging population, minimal wage growth, long work hours and rising cost of living could foreshadow decades of economic paralysis. But those are the very challenges that startups were born to solve. Stuck at your desk late? Order groceries from your phone. Frustrated with the salary at your 9-to-7 job? Enter the gig economy. In that light, China's grocery-delivery startups may have arrived just in the nick of time. 

Haitong assumes an average of 50 yuan ($7.29) per order.

To contact the editor responsible for this story: Rachel Rosenthal at rrosenthal21@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Shuli Ren is a Bloomberg Opinion columnist covering Asian markets. She previously wrote on markets for Barron's, following a career as an investment banker, and is a CFA charterholder.

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