Nongfu Spring: Grasping Tea Drinks, Water Reeds Return

Nongfu Spring (9633.HK) released its 2022 full-year financial report after the close of trading on March 28th, Beijing time, with the following key points:

1. Despite a drop in growth rate, the performance remains steady

In the first half of the year, due to travel and outdoor activities being blocked, the overall revenue growth showed a downward trend. With limited operating environment, the market will naturally not ask for faster growth for the company under such circumstances.

However, the high temperature and hot summer in the third quarter gave the market a boost, and just like the performance of the beer sector, the third quarter can be considered a small peak. As an absolute leader in the domestic beverage industry, Nongfu Spring naturally receives high expectations from everyone, and the market has given a moderately expected target with growth requirements of only 16% for the second half of the year. From the company's completion situation, it can be regarded as reaching it with a few bumps and twists.

2. Expand the gap in product categories, and tea beverages contribute the most

Although the overall goal has been achieved, there are still many small differences in the details.

1) Tea Beverages: This year, mainly relying on tea products, the company has made a small fortune, otherwise the overall performance will be difficult to explain.

The performance of tea beverages in the first half of the year was already very outstanding, and it continued to surge in the second half of the year, exceeding market expectations. As far as the current development is concerned, the 20% revenue contribution rate is not small, and it can still maintain such a high growth rate, which provides strong support for the company's overall performance. Combining the profit level of this business, we can only praise Nongfu Spring for its efforts.

Packaged Water: As a cornerstone of the Nongfu Spring family, the performance of the packaged water business basically determines where the company's growth center is. Last year in the second half of the year, the performance of this business was also very average, slightly below market expectations.

Due to the lack of consumer scenarios in the first half of the year, the growth rate was less than 5%, and the growth in the second half of the year was also slightly weak, less than 10%. The revenue contribution rate of more than 50% also pulled down the overall growth of the company.

3. The core profit is stable

We only consider the revenue performance related to the main business and evaluate it as the core profit of the company by simply looking at the gross profit excluding sales and management expenses. In the second half of the year, it reached 4.1 billion, slightly exceeding market expectations. The stabilization of gross profit margin and the control of expense ratio both played a relatively positive role.

Regarding the gross profit margin, the company has already explained in the mid-term performance report. The reason why the gross profit margin in the first half of last year was still acceptable is mainly because raw materials used in the first half of 2022 were already locked in 2022 with an acceptable increase in cost. However, low-cost raw materials were exhausted in the middle of last year, and the company had to settle for using expensive raw materials for the second half of the year.

Therefore, based on the price of PET at that time, the company's guidance was relatively conservative, and the gross profit margin for the full year was between 56-57%, which basically implies that the gross profit margin for the second half of the year was less than 55%. As a result, the market's expectation was not high. However, everyone may already know that PET prices began to decline later, and cost pressures began to ease, so the gross profit margin for the second half of the year and for the whole year was slightly higher than the market's expectations, although it was still slightly lower than the same period last year. 4. The improvement in expenses is quite significant, and controlling costs is the key to core profit growth. In the first half of the year, due to limited activities, sales expenses were put under cautious investment, which saved the company a lot of money. However, due to the impact of R&D expenses from stock incentives, the administrative expense ratio slightly increased during the same period. The performance in the second half of the year was optimized on this basis.

Marginal examination shows that while maintaining a stable sales expense ratio in the second half of the year, administrative expenses were further compressed. Regarding incentive expenses, although the amortization pressure on this year and next year will be further reduced, the company may also implement a new stock incentive plan (judging from Nongfu Spring's profit level, the probability is still relatively high). Therefore, Dolphin believes that when dealing with changes in expense ratios in the future, one should not be overly optimistic, and saving money blindly will not always be a good thing.

Multi-party efforts have finally led to profit growth. The gross profit margin is within a controllable range (although there is a decline, it is already expected), and the result of controlling expense ratios is that the performance of profit margin will not drop anymore. The growth rate of profit in the first half of the year (excluding exchange rates and interest income) was lower than the growth rate of income, which was really embarrassing. The performance of net profit margin can only be redeemed through other income.

However, in the second half of the year, after being supported by the high-growth of the tea beverage business, the enhancement of core profitability, and more abundant other income (including interest, etc.), the company's net profit growth achieved very good results, reaching 26%, which is far higher than market expectations.

Dolphin’s overall opinion:

Overall, Nongfu Spring's performance in the second half of the year has proven that the company is gradually overcoming the past brief period of darkness and returning to normal.

In terms of business, although packaged water, as the company's main focus, did not grow very impressively, to be honest, this business has already developed to a considerable size. The high growth in 2021 is affected by the base. Compared with previous years, the compound growth rate has shown a slowdown. This business should actually consider setting a more reasonable expectation.

By stabilizing the basic disk through the packaged water business and injecting more growth vitality into the company through tea product business, the company can only maintain the central growth rate between 10-20%.

In terms of profitability, Nongfu Spring, which has experienced several rounds of fluctuations in raw material prices, believes that in the future, it will be more adept in balancing gross profit margin and expense ratio. The relatively high profitability and massive revenue scale are truly creating generous cash returns for the company every year. A cash cow, indeed.

In the past six months, Nongfu Spring's stock price has been stable as Mount Tai, independent of the market. It rises as it pleases, and falls without affecting me. There is no issue in the company's operation. However, considering the impact of the current shareholding structure on market liquidity and the high valuation, Dolphin really cannot find the right opportunity to invest. If you are interested in following the management's discussion during financial report conference calls, Dolphin, the Changqiao App Community Platform, or investment research groups will share the conference call notes through the Changqiao App Community Platform or investment research group. Users who are interested are welcome to add the assistant's WeChat account "dolphinR123" to join the Changqiao Dolphin Investment Research Group and get the information first.

Nongfu Spring Product Matrix

Detailed Interpretation of the Financial Report:

I. Overall Performance: Although the growth rate has declined, the overall situation is stable.

Although the company's annual revenue growth rate has declined, considering the operating environment last year, this achievement is not easy. Especially in the second half of the year, it achieved a relatively stable growth rate, which met market expectations, although there are differences between revenue items and the market.

In terms of profit performance, benefited from the well-controlled decline in gross profit margin and continued optimization of expenses, the company's profit growth rate performed synchronously with revenue. Coupled with the abundant other income in the second half of the year (mainly financial interest), the performance of net profit was especially beyond expectations.

II. Packaged Water: Slower growth is normal.

Actually, the performance in the second half of the year was slightly lower than market expectations, with revenue less than RMB 9 billion and growth of only 9.5%. In addition, the performance of the packaged water business in the whole year was not satisfactory.

Of course, the company has also made many efforts for this, such as adjusting the capacity of large package bottled drinking water and launching new capacity specifications to make up for the sales loss during the logistics blockade period.

In terms of marketing and promotion, the company has continued to play its past marketing advantages. The brand advertisements and slogans of Master Kong have always given consumers a deep impression. The company continues to promote its brand image through video-type promotion methods.

Considering the pressure of rising costs in the early stage, the company started to raise the price of some bucketed water in Hangzhou in early February of this year, and the price of the 19L large bottled water product was increased by 10% to RMB 22. However, the impact is still relatively limited. Because the largest part of packaged water sales is small packaging, accounting for more than 60%, and the price range of small packaging products is very firm, it is very difficult to break through. Moreover, because it involves a wide range, blind price adjustments may have unfavorable effects on the enterprise image.

Therefore, in the packaged water business sector, it is mainly driven by quantity, which cannot be a driving factor for maintaining high growth sustainably. In terms of prices, a good way is to indirectly raise prices through structured upgrades, but the audience for high-end water products is relatively limited. It is not very practical to rely on the company to create any huge waves in this regard.

Three, tea drinks: large base, significant growth

Observing the growth trend of the tea drink business in the past two years, it is very pleasing and has become the favorite of investors. In the second half of the year, tea drinks continued to achieve good results with more than 50% growth, and revenue remained stable at more than 3.5 billion, greatly exceeding market expectations.

There are reasons why it can continue to exceed expectations. With HeyTea on the left hand, and Dongfangyun on the right hand, Nongfu Spring has firmly grasped the needs of young and middle-aged consumers.

HeyTea: Targeting young products, using the continuous introduction of new products and online promotion to attract more customers. On the product side, it continuously adjusts taste and specifications to expand consumption scenarios. On the marketing side, it collaborates with popular campus culture to deepen interaction with target customers, strengthen product image, and gain attention.
Dongfangyun: Continuously insinuates product superiority and emphasizes Eastern culture. By highlighting the advantages of "0 sugar, 0 calories, 0 fat, 0 flavoring, and 0 preservatives", it caters to the health and wellness needs of target customers. Moreover, by enriching the product matrix through seasonal limited edition products, it creates a sense of freshness.

Four, fruit juice needs to become a bright spot

Compared with the second half of last year, the performance of functional drinks and fruit juice drinks has been relatively ordinary, and there are both good and bad performances compared to market expectations, but the impact on overall operations is not significant due to their small business volume.

Among them, the performance of fruit juice drinks is slightly better, and it is expected to become a new bright spot for the company in the future. The main determinant is still the difference in product strength.

In terms of functional drinks, Nongfu Spring does not actually have much advantage. The company's main products are "Scream" and "Vitamin Water". However, the difference between these two and other sports drinks is not significant compared to professional functional drinks such as Red Bull.

At present, it can only be promoted through marketing activities such as joint sponsorship, and the success rate is not high.

In terms of fruit juice drinks, the company's product strength is stronger. The most important thing here is the raw material link and process level. On the one hand, it controls the source of raw materials and emphasizes the positioning of high-end quality. On the other hand, it also maintains the taste of freshness with a high process level. Nongfu Spring has an advantage in both of these aspects.

Five, cost pressure begins to improve

In this period's financial report, Dolphin believes that the contribution of gross profit margin is second only to the high growth of tea drinks. The main reason is that compared to cost optimization, the stability of gross profit margin in the future is stronger. Of course, the slight performance of this period's gross profit margin exceeding market expectations is due to the company's early preventive measures, so the market expectations are not very high.

In the second half of last year, the company's gross profit continued to exceed 9 billion yuan, although the gross profit margin dropped by 2.3 percentage points, which is more than the decline in the first half of the year. However, the company had already done psychological preparation for everyone in the middle of last year and gave a guidance for the full-year gross profit margin of 56-57%. Market expectations can basically only give a gross profit margin of 55.7% for the second half of the year (still considering the impact of PET prices going down), which makes it a bit easier to achieve.

After the outbreak, the company's overall gross profit margin is basically stable at around 60%, but the PET price increase that followed the fluctuations of crude oil prices in 2021 is more obvious. Even if the company can use economies of scale to lock in prices, inventory will eventually be depleted, and starting from the middle of the year, you can only buy as needed.

PET accounts for more than 30% of the sales cost, and the average price of PET in 2022 has also risen by 18%. Therefore, despite having a fixed quantity at a fixed price, it is impossible to completely avoid any impact on the gross profit margin. However, fortunately, PET prices began to go down after the middle of last year. Although it has not returned to the previous low point, considering the impact on the cost base in the previous period, the pressure on the gross profit margin has been greatly relieved, and it is very likely to be stabilized.

VI. Continuous improvement in expenses, and the growth rate of profits keeping pace with the growth of revenue

As the fluctuation of the gross profit margin in the second half of the year is only 2 percentage points (expected to decline by 3-4 percentage points), it is not too much, so slightly buffering on the expense rate will basically keep pace with the profit margin level.

In the first half of last year, the mismatch between revenue and profit growth was mainly due to the equity incentive and R&D expenses consuming some improvement in sales expenses. Coupled with lower revenue growth, it was difficult to consider the profitability.

Considering the impact of the base period in the second half of the year, administrative expenses have relatively improved, and there is no need to increase investment in marketing activities in the operating environment last year. Therefore, the combination of the two shows that the change in operating profits is not as obvious as in the first half of the year.

However, what the Dolphin Investment Research would like to emphasize is that saving money is not a magic trick for sustainable development. When the industry is in difficulty, it is possible to be frugal, but more incremental income is also determined by how to spend money and reflect it in the growth of revenue.

Dolphin Investment Research "Nongfu Spring" historical articles:

Financial Report Season

August 25, 2022, Financial Report Review "Nongfu Spring: Tea Drinks Thrive Against The Trend, Can "Water Mao" Control Itself In The Second Half Of The Year?" 2022 August 25, conference call "Tea Beverage Products Became a New Growth Point"

2022 March 30, conference call "Summary of Nongfu Spring 2021 Annual Performance Exchange Meeting: Sales Targets Basically Achieved" (https://longbridgeapp.com/topics/2213926?channel=t2213926&invite-code=FRQWBJ)

2022 March 28, financial report review "Nongfu Spring: The Return of the 'King of Water Grass'" (https://longbridgeapp.com/topics/2201674?channel=t2201674&invite-code=FRQWBJ)

2021 August 25, financial report review "Nongfu Spring: The Return of the 'King of Water Grass', But Valuation Risk Should Not Be Ignored" (https://longbridgeapp.com/topics/1079379?invite-code=032064)

2021 March 29, conference call "Summary of Nongfu Spring 2020 Performance Conference Call" (https://longbridgeapp.com/topics/726228?invite-code=032064)

2021 March 26, financial report review "Nongfu Spring: Did the 'Water Grass' Performance "Inject Water"? (https://longbridgeapp.com/news/31949209)

Deep Dive

July 20, 2021 "Nongfu Spring (Part 2): How Much Room is There for a 'Rational' Rise?"

July 14, 2021 "Nongfu Spring (Part 1): Tell a Story about Drinking Water and Thinking about the Source"

Risk disclosure and statement for this article: Dolphin Research Disclaimer and General Disclosure