Redmart is a Singapore-based online grocery store that was founded in November 2011. Its strategy is to operate its own logistics and warehouses to deliver groceries to customers.
It’s recently featured in Tech In Asia (see this link) and here’s the reported revenue figures:
In 2015, it reported net loss of 70m, out of which over 70% of that figure was non-cash losses. As such, its operating loss for 2015 was USD 21m with operating loss margin of 78%, which was maintained from 2014. The Company expects to be self-sustainable by mid-2017.
Let’s do some analysis to estimate when it can achieve breakeven point (zero operating profit/loss). We need a peer for this analysis, and Sheng Siong comes handy with all its public financial statements. Sheng Siong runs brick-and-mortar supermarket, different from Redmart’s online store, but some of the costs and margins can be used for comparison.
Sheng Siong made SGD $764m revenue in FY15 (20x Redmart’s) with gross profit margin of 24.7% (similar gross margin to Walmart’s). In FY15, Sheng Siong also achieved the highest net margin in years with 7.4% and net profit of 57m. If we look at its FY15 annual report, we’ll see that the employment expense was nearly 99.4m, or 13% of revenue. Operating lease expense was only 21m or 2.75% of revenue.
Let’s use the most optimistic case for Redmart. We assume that Redmart achieved the same gross margin as Sheng Siong at 24.7%. That means with USD 27m revenue, its gross profit was 6.7m, and the total operating cost was 21m + 6.7m = 27.7m. Next, we assume that current operating capacity, such as warehousing, truck delivery, manpower, is underutilized. These resources have been invested in advance and will run at full capacity when Redmart reaches breakeven point. In other words, these costs will stay flat while the revenue is growing until the breakeven point.
With gross margin of 24.7% and operating costs of 27.7m, the estimated revenue for breakeven point in most optimistic case is 27.7/24.7% = USD 112m. That revenue estimate is 4.15x of 2015’s revenue. Based on last year’s revenue growth rate of 181%, Redmart will need about 2.5 years to achieve 112m revenue.
However, the optimistic case is clearly not rational. Redmart can invest in warehousing in advance, but it cannot and will not do so for its logistics and manpower. To avoid excessive losses from the underutilization, Truck delivery and manpower are likely to be invested as the revenue scales up. Warehousing too, I believe, will have to be invested when the current revenue triples or quadruples. Therefore, the operating costs will definitely increase along with the rising revenue.
Redmart’s gross margin is also not likely to be as high as Sheng Siong’s. Sheng Siong’s gross margin actually grew from 20% in 2008 to 24.7% in 2015. So, as it scales up, Sheng Siong manages to get the products from the suppliers at better price or has a better product mix and sells more of higher margin products. Unless Redmart focuses more on higher margin products, its gross margin will be lower than Sheng Siong’s.
As Redmart scales up, its customer acquisition costs and advertising costs as percentage of revenue could drop. This is its potential cost cutting to improve margin. However, Redmart can’t remove these costs completely as it relies on online advertising for promotion and to bring in new customers.
Therefore, with 1) lower gross margin, and 2) major operating costs that will scale up with rising revenue, we should expect Redmart to continue reporting losses for probably several years down the road even when current revenue quadruples or quintuples.
Let’s segment the customers to see who will or will not use Redmart’s service.
- Cost sensitive customers: this group will always find the cheaper groceries to save money. It’s hard for Redmart to sell the products cheaper than its established peers because they have much larger scale, and their existing margins, such as Sheng Siong’s, are not high. I have heard from several friends who said Redmart’s products are not cheap. This group is not likely to use Redmart’s service.
- Membership: this group signs up membership with some supermarkets or hold credit cards that give additional discounts. NTUC Fairprice and Sheng Siong, for example, give additional 5% discount for their members or certain credit card holders. Redmart may occasionally work with some credit card companies for such promotion, but it’s not long term promotion. This group is not likely to use Redmart’s service.
- Staying very near to grocery stores: this group can shop conveniently in nearby supermarkets/convenience stores/mini mart and don’t mind shopping. In densely populated area in Singapore, we can often find nearby supermarkets. Majority of this group is not likely to use Redmart’s service.
- No one at home: this group has no one at home to receive the grocery delivery (I’m one example). Many young Singaporean family (those without maids) have no one at home during the day time.
- Having maid to shop: the family have maids to do the grocery shopping. They may prefer to continue doing so. However, some may prefer to use Redmart so that the maids can’t go out.
- Staying far from supermarkets: this is good target customers for Redmart.
- Preference for convenience (and stay at home often): this is the best target customers for Redmart. Online order also allows them to track the expenses easily and the order details are provided in emails.
If we remove the customers from group 1 to 4, the market size that Redmart is serving becomes much smaller. For Redmart to compete, they must find a niche and excel in it. They can’t fight heads on with the existing retail players to win customers from group 1 to 4 above.
In today’s world, you will never be able to do a business without competitors. Several online grocery stores, such as Honestbee, PurelyFresh and GoFresh, have sprung up to compete. Honestbee, for example, received millions of funding and operate without having warehouses and trucks. Existing supermarkets, such as NTUC Fairprice, Cold Storage, have also entered e-commerce space some time ago.
Redmart might be the first player to make it big in online grocery in Singapore, but there is really no clear additional advantage like first mover or network effect. Customers can always switch between the online sites without incurring any costs at all. Being the largest in Singapore does not mean anything if it’s to start operating in Kuala Lumpur. The size matters only in the local market that it operates in, not on regional or global basis.
When Redmart is running at full capacity, it will have to invest in additional warehousing and logistics to earn additional revenue. Hence, it’s not easy to scale. If it’s to expand to other cities in South East Asia (SEA), it will have to handle logistics differently because different countries have different infrastructure and culture.
Online grocery is not a new business model to disrupt the traditional grocery market today. In late 90s, there is a company in US, called Webvan, that did what Redmart is doing. Webvan even went listed in 1999 and was valued at more than $4.8 billion. But it went bankrupt in 2001 as it ran out of cash.
All is not negative though. There are many other online grocery stores around the world, some of which have been operating for many years, presumably with profits.
Grocery is a low margin business. If we compare the cost structure of online grocery store with traditional grocery store, the first item to compare is rental vs delivery cost. Online store saves the rental by operating in a big warehouse with lower rent, while retail store pays higher rent to get strategic location in crowded area.
Online store incurs much higher transport costs to deliver goods to customers, while large retail store doesn’t have this kind of costs, except for distributing goods from their own warehouse (distribution centre) to retail stores. In some cases, suppliers distribute directly to the retail outlets. Deliveries to customers also possess additional challenges, such as bad traffic, bad weather, risks of accident, late deliveries, customers not at home, wrong items picked, etc.
Sheng Siong’s operating lease expense in FY15 was 21m or just 2.75% of revenue compared to labor cost of 99.3m or 13% of revenue. If Redmart is to achieve Sheng Siong’s operating margin, assuming all else equal, then its delivery cost has to be around 3% of its revenue. This is very difficult to achieve considering that the overall costs of operating motor vehicles are very high in Singapore.
In terms of labor costs, Redmart will need many more delivery drivers than traditional grocery stores. It does not need cashiers but will still need labors to pick and pack the online orders. So, the role of cashiers are converted to pickers for online grocery stores. When operating near full capacity, you can expect the pickers to be constantly working to fill up orders. Cashiers, on the other hand, may have less to do, especially during non-peak period. Redmart will have to execute very efficiently to lower its labor costs.
In order for Redmart to generate competitive margins compared to Sheng Siong’s, Redmart has to operate very efficiently and utilize its labor resources and truck deliveries at near full capacity. It’s a matter of excellent execution to create value for the shareholders.
Overall, given the smaller market size, likely lower gross margins and higher operating costs from transport, I think that Redmart is fighting a very tough battle. It seems to me that its business model is flawed just like Webvan’s. It’s likely to continue making losses and will need additional funding to avoid running out of cash.
I don’t have details about Redmart’s financials and current operation metrics, so any valuation estimate here is really pointless. However, using the framework we previous discussed to value fast growing stocks, we can do a quick and rough estimation.
If we assume Redmart’s revenue to grow at 50% per year for next 4 years, it will achieve 200m at the end of four years. Next, if we assume the net profit margin is 5% (lower than Sheng Siong’s 7.4%), then the profit estimate is 10m. Multiply the earnings by Sheng Siong’s current P/E of 23x will generate market cap of 230m for Redmart four years from now.
This 5% net margin is quite optimistic. Just imagine that if the margin assumption is 3%, then the net profit estimate will drop to to 6m. Assigning P/E of 23x may also be too aggressive. As you can see, changing the assumption slightly can impact the valuation by large percentage.
When valuing fast growing companies, the likelihood of error is much higher because the company may not meet the high expectations for variety of reasons. You can change any assumption slightly and the impact can be huge to the overall valuation. I don’t have the skills to value such company and will not attempt to do so.