Meituan: A Regulatory Reset Is Overdue For China's Food Delivery Leader (Rating Downgrade)

Meituan (HKG:3690) stock has significantly underperformed the Hang Seng Index (HSI) since my previous update in August 2023. I urged investors to consider capitalizing on its ongoing recovery, notwithstanding China's macroeconomic and regulatory uncertainties. Since then, the Chinese government has stepped up its antitrust crackdown on internet giants, with Meituan being the latest target. The State Administration for Market Regulation (SAMR) has ordered Meituan to rectify its algorithm rules, urging the company to make its algorithms more transparent and fair. This comes after Meituan was fined 3.442 billion yuan (approximately $534 million) for monopolistic practices in April 2024.



With MTHY notching a 1Y total return of less than 10%, I believe it's timely for us to assess whether the current levels are still reasonable to add more exposure. The company's third-quarter or FQ3 earnings release demonstrated Meituan's ability to continue gaining operating leverage as it scales. Accordingly, MTHY posted an EBIT margin of 15.2%, with its quarterly operating income reaching a record high of RMB 11.2 billion. The company has benefited from the increasing penetration of higher-margin third-party or 3P services, including advertising, lifting its take rates. Accordingly, Meituan posted take rates of 18.7% in its commerce segment, up from last year's 17%.

As a result, MTHY has gained confidence to up the ante in the first-party or 1P segment, looking to gain market share against its smaller competitors. Notably, the company saw increased competition from Alibaba's (BABA) Ele.me, as it expanded its global scope to the Chinese market. An analyst on Meituan's FQ3 conference call was concerned with Ele.me's cross-border entry into China. However, Meituan highlighted that while the Chinese region isn't immune to aggressive competition, MTHY has faced more significant and well-resourced competitors, such as Alibaba or Southeast Asia's market leader Shopee (SE). Therefore, Meituan isn't unduly concerned and is confident about its increasing competitiveness across the value chain, "especially in logistics and payments."

Observant MTHY holders should know that the company operates an end-to-end platform in China, covering e-commerce, payments, credit, logistics, and fulfillment. As a result, I believe Meituan has benefited from its earlier investments to gain a distinct competitive edge. Therefore, new competitors determined to dislodge MTHY's stickiness with consumers and merchants would likely need to invest aggressively to gain market share. As a result, they could incur several years of losses even if they were successful. MTHY's increasing commerce take rates demonstrate the company's wide-moat value proposition, operating as a one-stop shop for its customers. Accordingly, the company delivered a fulfillment penetration rate of 48% in Q3, underscoring the improved user engagement "attributed to ongoing improvements in user experience."

Given Meituan's market leadership and dominance in a fast-growing region, we shouldn't be surprised that MTHY's quality isn't cheap. After its recent surge, it last traded at a forward normalized P/E multiple of more than 50x. While I didn't assess sell signals on MTHY, I believe near-term caution is warranted after its stellar performance over the past year. MTHY's volatility allows astute investors to exploit steep pullbacks at critical support levels that attract robust dip-buying support. I assessed the series of higher highs and higher lows point to MTHY's robust medium-term uptrend. While the recent surge appears to have lost upward momentum as it consolidates, I would consider buying its subsequent pullback, betting on an ongoing recovery that last saw MTHY nearly re-testing its late 2021 highs.

As a result, I urge investors to watch its crucial support levels closely for another entry signal, allowing us to improve our risk/reward profile further. Rating: Downgraded to Hold. Important note: Investors are reminded to do their due diligence and not rely on the information provided as financial advice. Please always apply independent thinking and note that the rating is not intended to time a specific entry/exit at the point of writing unless otherwise specified.