A hot pot chain opened 850 new restaurants in the pandemic. What could go wrong?

The COVID-19 pandemic discouraged indoor dining, food sharing, and close quarters. That was bad news for most restaurants, but it seemed to be a death sentence for hot pot shops, a Chinese “family-style” dining concept in which large parties dip meat and vegetables into communal vats of flavored soup.

Chinese hot pot chain Haidilao—known for its customer service–focused restaurants that offer free manicures, snacks for diners waiting in line, and even a giant teddy bear companion for those dining alone—didn’t see it that way. Instead of waiting out COVID lockdowns and capacity restrictions, the Sichuan-based chain launched an expansion plan that would have been ambitious in a normal year, let alone in pandemic times, when takeout—alone on a couch—was all the rage.

In 2020, Haidilao expanded at its fastest pace ever, opening 544 new restaurants, an average of 1.5 shops per day. In the first six months of this year, Haidilao opened another 299 restaurants, to reach 1,967 outlets worldwide.

Haidilao founder Zhang Yong was wagering that the pandemic would be over in a matter of months—and that it was an opportune time for the company to broaden its footprint.

Zhang’s bet went horribly wrong. Haidilao’s profits sank by over 200% from June 2019 to June 2020. In the first half of last year, it recorded a $151 million loss amid weaker-than-expected new-store performance and changing consumption habits. Haidilao’s expenses grew 80% to $29 million in that same period, mainly owing to store-expansion–related liabilities.

Haidilao returned to profit in the first half of this year, recording a $15 million gain. Even so, the company acknowledged that its business performance and table turnover rate didn’t meet management’s expectations.

Investors have been equally disappointed. As of Tuesday, Haidilao’s share price had plummeted 75% since its February 2021 peak, wiping $43 billion off its market cap. On Hong Kong’s Hang Seng Index—which tracks the 50 largest Hong Kong–listed companies—Haidilao’s stock is the worst performer this year, notching a 65% decline.

Now, 18 months in, Haidilao is finally admitting that its aggressive expansion strategy was severely mistimed and mismanaged.

The company had been “too confident” in its expansion plan, Zhang said at a recent company meeting.

Haidilao is closing 300 underperforming shops, or one-fifth of its total restaurant count, in the next two months and has a new business plan focused on improving the operations and profitability of existing stores, according to a Friday filing to the Hong Kong Stock Exchange.

Investors seem relieved. On Monday, Haidilao’s long-suffering stock climbed as much as 11% and jumped another 5.8% on Tuesday.

Pandemic-era hot pot

When the pandemic first began in China in January 2020, Haidilao was an early victim. The government forced Haidilao (and other food and beverage chains like Starbucks) to temporarily shut all its shops in mainland China, where the bulk of its restaurants are located.

Haidilao started reopening some of its restaurants when China’s initial outbreak subsided in mid-March 2020, but customers didn’t come rushing back.

Many patrons shunned the communal dining experience in favor of other options, like takeaway at home, says Jason Yap, founder and managing partner of investment research firm Logos Advisors, who publishes on the SmartKarma platform. Other customers were put off by higher menu prices that Haidilao had introduced after its closures. Plus, government pandemic restrictions limited the number of tables—and the number of diners per table—Haidilao could serve.

Haidilao’s year-over-year same-store sales growth rate has declined significantly since reaching 6.4% in 2018. Growth dropped to 1.6% in 2019. Same-store sales plunged 17.7% in 2020, and declined another 2.8% in the first half of this year.

Meanwhile, table turnover dipped from 4.8 per day in 2019 to 3.5 in 2020, and 3.0 in the first half of 2021. For its new restaurants, the rate was even lower at 2.3 per day this year.

Still, the hot pot chain kept opening new restaurants. Haidilao management believed that the food and beverage sector would rebound quickly in China, and that the pandemic offered the chain an opportunity to grow when other shops were shutting down.

But for every new hot pot store that Haidilao opened, it racked up $488,000 in costs, based on the $565 million it had allocated to its expansion plan. And it made the mistake of locating restaurants too close together; new stores “cannibalized business” at its older stores, says Yap.

Turning the tables

The Sichuan-founded hot pot chain had its sights set on global growth in recent years; it opened eight locations across the U.S. with shops in Los Angeles, San Francisco, Seattle, and New York. But Haidilao’s international expansion will have to wait for now. New shops will be curbed in the near term, says a Monday Fitch report, and the company needs time to “determine the appropriate restaurant concentration rate.”

The hot pot chain’s 300-store shutdown and new business strategy has boosted analysts’ outlook for the company.

Haidilao’s new game plan will improve its store operation and profitability, divert customers to the remaining shops, and improve its cash flow, wrote Jefferies analyst Anne Ling in a Nov. 7 report.

“Closing such restaurants should increase productivity for the remaining stores,” the Fitch report said. Still, Haidilao will face one-off costs from its store closures that will sink earnings in the near term, Nomura analysts said in a note, and the company faces an uncertain recovery since China is now battling its worst COVID outbreak since the start of the pandemic.

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