Hongjiu Fruit Gets IPO Go-ahead but Cash Flow Concerns May Bite

Hongjiu Fruit has gained approval to list its shares in Hong Kong but soaring levels of customer credit could curb investors’ appetite

Key Takeaways:

• Hongjiu Fruit specializes in high-value fruit and was the biggest distributor of branded fresh fruit in China last year in revenue terms
• The company’s rapid expansion of new retail channels has raised cash flow risks, with trade receivables surging above 5.9 billion yuan in the first five months of the year

By Emily Chan

A company that serves the top end of China’s fruit market is aiming to tickle investors’ taste buds with a Hong Kong stock listing, as it cashes in on consumers’ growing appetite for the flavors of durian or dragon fruit.

Chongqing Hongjiu Fruit Co. Ltd., one of China’s three fresh fruit giants, passed its listing hearing in late July and looks set to proceed with its IPO on the Hong Kong Stock Exchange this month.

The company counts tech giant Alibaba (BABA.US; 9988.HK) among its stakeholders, and its business model – focusing on wholesaling six main types of high-value fruit – has generated tantalizing revenues. But problems collecting outstanding payments from its expanded distribution network could leave a sour taste for investors.

Market sources said the company planned to raise up to $300 million from the IPO. If successful, it would beat fellow fruit firm Shenzhen Pagoda, which submitted a listing application in May, to become the first fruit distributor to launch on the Hong Kong exchange.

Hongjiu Fruit raised just over 2 billion yuan ($310 million) before filing for its Hong Kong IPO, according to its preliminary prospectus. In the last round of Series C+ financing in 2020, Alibaba (China) subscribed for 8% of the shares for 591 million yuan, becoming the largest external shareholder, sending the company’s valuation to 7.39 billion yuan.

China is the world’s largest fruit producer and one of the largest fruit consumers. Its market is dominated by three players each with a geographic focus: Pagoda in the south, Xianfeng Fruit in the north and Hongjiu in the west.

The other two market leaders are more consumer oriented than Hongjiu Fruit. Pagoda operates in the retail chain market and Xianfeng is exploring a franchise model. Founded in 2002, Hongjiu Fruit specializes in distributing premium fruits through a variety of channels that cater to consumers who are keen to upgrade from staple fruits to sample new flavors.

Seeking to differentiate itself in the fruit business, the company launched its first brand of longan, a fragrant fruit related to the lychee, in 2013 and quickly dominated that niche.

Since then, Hongjiu Fruit has repeated its winning formula by launching its own brands in several categories, forming a produce portfolio with durian, cherries, mangosteen, longan, dragon fruit and grapes as its six core products.

A survey conducted by China Insights Consultancy, quoted in the prospectus, found that Hongjiu Fruit was the biggest distributor of own-brand fresh fruits in China. It is also the largest distributor of the pungent durian fruit, and ranks among the top five for dragon fruit, mangosteen and longan in China based on 2021 revenue. Sales of its range of branded fruits contributed 73% of total revenue.

Revenue ripens despite the pandemic

Hongjiu’s sales have climbed steeply over the last three fiscal years. From 2.08 billion yuan in 2019, revenues more than doubled in 2020 to 5.77 billion yuan and surged again to 10.28 billion yuan in 2021. 

The bottom line has also raced upwards. The company’s adjusted profit (using non-IFRS measures) leapt from 228 million yuan in 2019 to 662 million yuan the following year and broke through the billion-yuan mark in the last financial year, coming in at around 1.09 billion yuan.

Even a resurgence of the Covid pandemic could not quash the growing taste for premium fruit.

In the first five months of this year, the company’s revenue rose 25% from the year-earlier period to around 5.73 billion yuan, while adjusted profit increased nearly 40% to 745 million yuan.

But behind the high growth figures, Hongjiu Fruit is facing mounting operational pressure.

The average selling price of its fruits has declined over the past three years, with a strategy shift to introduce some lower margin fruits and expand sales outlets. As a result, gross margin fell from nearly 19% in 2019 to just under 16% last year.

However, gross margin rebounded in the first five months of this year, jumping to just under 20% as the company phased out a two-year marketing campaign.

Hongjiu Fruit has invested in building a leaner, digitally driven “end-to-end” supply chain, and started to adopt a policy of direct sourcing at origin in 2017. The company set up factories in fruit-producing areas to process and grade fruit that is then sold through a digitally managed distribution network.

With the benefit of supply chain control, Hongjiu Fruits said in its prospectus that it is one of the few companies in China’s fresh fruit industry that can meet the internationally recognized ISO 9001 standards for quality management.

The company has actively sought to adapt to China’s changing retail trends as well as shifting shopping habits during the Covid pandemic. With grocery e-commerce booming, it sought links with e-commerce channels, set up 19 sales branches and opened 60 sorting centers nationwide to supply directly to supermarkets, specialist produce stores and community buying groups.

However, the performance of the retail channels is lagging expectations. While wholesalers accounted for more than 50% of total sales revenue over the past three years, the share generated through the new channels was only 20%. The contribution from supermarkets fell from around 19% of revenues in 2019 to 14% in 2021. In the first five months of this year, the retail revenue from supermarkets fell even further to just over 11%, possibly affected by pandemic lockdowns.

The retail arena targeted by Hongjiu Fruit is a competitive battlefield where assertive start-ups have gone bust or otherwise faltered. Another Alibaba-invested fruit company, Yiguo.com, filed for bankruptcy reorganization in 2020. More recently, Tencent-backed(0700.HK) online grocer Missfresh Ltd. (MF.US), which listed in the U.S. two years ago, has struggled to survive a cash flow squeeze after breakneck expansion.

5.9 billion yuan of receivables

Hongjiu Fruit’s balance sheet may not be entirely appetizing to investors, given the amount of money owed by customers who took delivery of produce on credit. 

Trade receivables in the company accounts, or bills that customers have yet to settle, have escalated over the past three years. Net of loss provisions, they were 708 million yuan in 2019, rising to 2.01 billion yuan a year later and 3.71 billion yuan in 2021. In the first five months of 2022 trade receivables soared again to 5.91 billion yuan.

Provisions for losses on trade receivables have surged in tandem, from around 21 million yuan in 2019, to 30 million yuan in 2020 and just over 55 million yuan last year. For the first five months of the year the figure already stood at 121 million yuan.

The company attributed the ballooning receivables to the rapid expansion of its business reach, adding that it had recently speeded up the collection of money owed.

Still, Hongjiu Fruit risks facing a cash flow crunch as its suppliers generally apply shorter credit terms than those offered to its customers. If changes in working capital exceed the size of profits, the result is negative operating cash flow.

Hongjiu Fruit had more than 7,000 suppliers at the end of May, the prospectus said. Problems collecting cash promptly from downstream customers could impede the company’s business performance.

For investors, that means being ready for a potentially bitter aftertaste if they decide to buy a slice of the Chinese premium fruit business.

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