Well ducked?

Neck on the block

“I’ll say they’re a fraud, and I’ll short. But when they do go to zero, I win, you all lose,” pronounced Dan David in the documentary The China Hustle. Over the past few years short-seller reports have mushroomed. Most have targeted overseas-listed Chinese companies and the bearish bets made by short-selling firms like Muddy Waters have often produced outsized returns. That’s because their authors’ claims to have uncovered misdeeds through their forensic financial investigations have then caused losses of confidence and driven down stock prices.

The most recent target is Hong Kong-listed Zhou Hei Ya. Famous for its store’s spicy braised duck neck, the Wuhan-based company was accused by Emerson Analytics of inflating its sales through creating receipts for “cancelled” transactions.

“Our tracking of the ‘Serial Number’ of a ‘Deal Cancelled’ sales slip often revealed that it would subsequently show up and be identified as an ‘Original Serial Number’ in a real transaction sales slip,” wrote the Hong Kong-based research group, warning this month that there could be a 33.5% downside hit to Zhou Hei Ya’s current market value.

The process allowed Zhou Hei Ya’s sales volumes to be exaggerated by 28% across its 11 retail outlets in Hunan and Jiangxi, alleged Emerson Analytics. The findings also suggested that the average spending per order in Zhou Hei Ya’s home market in Hebei was actually 6.8% below the national average. That translates to a net profit that is 52.2% lower than the Rmb533 million ($80 million) projected by the company.

Zhou Hei Ya responded in a statement that it only computes “orders coupled with payment”, and the practice of suspending sales orders is meant to assist customers who change their minds or wish to shop for more. “The accusation that the Group inflates its sales through intentional cancellation of sales orders is frivolous and without merit,” said the food chain.

Zhou Hei Ya’s share price surged 12.7% in the 12 days after the report was released, suggesting the market was not entirely convinced by Emerson’s analysis.

The stock bounce does not disguise the fact that the shares are off more than 50% from their 52-week high as its results have disappointed since it went public in 2016. In January the company issued a warning that its net profit last year would slump 30% from a year earlier due to higher production costs.

Zhou Hei Ya’s underperformance against its rivals has also been a concern. Changsha-based Juewei, for instance, saw its net profit rise 27.9% to Rmb642 million last year; Nanchang-based Huangshanghuang also logged a growth of 22.7% over the same period.

So what is holding Zhou Hei Ya back? Most analysts cite its adherence to the company-owned-company-operated (COCO) model, as opposed to the franchise-led expansion embraced by its peers. “COCO is an asset heavy model, which severely limits how fast Zhou Hei Ya can expand its footprint,” food and beverage analyst Zhu Danpeng told Time Weekly.

The company currently operates 1,196 stores, far fewer than Huangshanghuang’s network of 3,000 franchised outlets and Juewei’s 9,459 as of the first half of 2018. Juewei, in particular, has already established its presence in Hong Kong and Singapore, and is looking to extend its reach to Japan, Australia and Canada this year.

In an interview with WiC last year, Zhou Hei Ya’s founder and boss Zhou Fuyu said that it is his dedication to food safety and customer satisfaction that stops the firm from adopting the franchise model (see our Sinopolis guide on Wuhan for the full Q&A). “Running self-operated shops, it seems to me, is still the most reliable way to control quality,” said the 42 year-old Zhou, noting also that the spread of its store network in other provinces is also dependent on localising its production capacity (given the food’s perishable nature).

The message from the boss is to ‘stay patient’ given that three new regional food processing facilities are being built.

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