Nongfu Spring (9633.HK) released its performance for the first half of 2024 after the Hong Kong stock market closed on August 27th Beijing time. The key points of the financial report are as follows:

1. Bottled water sales are severely lagging behind

After the Spring Festival, the online criticism surrounding the packaging design of Nongfu Spring from the family of Zhong Shantong, the founder of Wahaha, to the launch of the cheap green bottled purified water by Nongfu Spring in early May, and a series of public relations events including the Hong Kong Consumer Council, the market knew it was bad, but didn't expect it to be this bad:

The core business of bottled water directly shrank by more than 18% year-on-year in the first half of the year, even the pandemic didn't cause such a decline, while the market's expectation was only around a 10% year-on-year decline.

2. Ready-to-drink tea has become a top player alongside bottled water

Despite the decline in bottled water sales, RTD tea remained exceptionally strong amidst a series of public relations challenges: represented by Oriental Leaves, the revenue from tea drinks still saw close to a 60% year-on-year high growth, with an additional revenue of over 1 billion compared to the second half of last year, surpassing seasonal high growth, indicating that tea drinks are still in a phase of explosive growth.

In terms of revenue, the revenue level of tea drinks at 8.4 billion in the first half of this year is comparable to the 8.5 billion level of bottled water, and looking at the trend, although Nongfu Spring mentioned that 10 billion is the ceiling for soft drink business, judging from the current growth of tea drinks, the ceiling for unsweetened tea is clearly higher.

3. Functional beverages and fruit juice are still not mature

The revenue growth of functional beverages in the first half of the year was only 4%, perhaps due to sales being hindered by public relations events and the weak demand for outdoor sports in the second quarter due to floods. The 25% growth in fruit juice and a revenue of over 2 billion in the first half of the year are basically stable and on the rise. However, these two businesses have small volumes, low profit margins for fruit juice, and do not have much impact on the two main businesses of water and tea.

4. The one-yuan water price war hurt revenue and profit

In the first half of the year, Nongfu Spring's gross profit margin of 58.8% was lower than the second half of last year and lower than the same period last year, also lower than the market's expected range of 59.5%.

As an essential product that consumers will buy regardless of price, and with many consumers unable to distinguish between the red and green bottled water, many who would have bought red bottled water switched to green bottled water. The impact of the one-yuan water price war on the company's overall gross profit margin is visible: the operating profit margin of the bottled water business dropped directly from 36% to 32%.

Furthermore, looking at profit by category, the rise in sugar costs in the first half of the year may have also affected the profitability of functional beverages and fruit juice.

5. Fortunately, expenses are relatively controlled, and profits barely meet expectations

Although selling cheap water has hurt Nongfu Spring's revenue and gross profit margin, the company's expense control is still very strong. The low prices have mostly affected the gross profit margin, but Nongfu Spring has been relatively restrained in marketing and advertising expenses, with administrative expenses even showing a rare negative growth.

In this way, despite the slight underperformance in overall revenue due to bottled water, both the core operating profit (revenue-cost-three fees) that Dolphin Jun is most concerned about, and the net profit on the company's financial statements, have basically met expectations, slightly exceeding them

Dolphin Research Point of View:

From this financial report, the significant drop in revenue by nearly 20% and profit by close to 30% in the pillar packaging water business indicates that the stagnant online sales of Nongfu Spring, reduced display in offline stores, and the subsequent one-yuan price war in the bottled water market have indeed caused considerable damage to Nongfu Spring.

However, the real killer logic lies in the market competition deterioration that concerns capital under the one-yuan water war. After the growth of Nongfu's packaged water business reached its peak, industry competition intensified. Coupled with weak consumer demand, Nongfu Spring's valuation has been slashed to around 25 times PE ratio.

Nevertheless, in assessing the current investment in Nongfu Spring, Dolphin prefers to approach it from another perspective:

a. The timing of Nongfu Spring's launch of the green bottled purified water - the end of April, coinciding with the listing time of its old rival, Yi Bao. From the packaging choice of the 550ml green bottled Nongfu Spring purified water resembling Yi Bao to the slogan "I have the obligation to inform you, you have the right to choose, more choices, more comparisons" (implying, compare with whom? Who offers more choices? Isn't it Yi Bao?).

It seems that this so-called one-yuan water war is more like a precise sniper attack by Nongfu Spring at the time of its old rival's listing. In other words, unlike the passive response to the increasing number of real industry players in the e-commerce track as seen by Dolphin, Nongfu Spring seems more like the industry leader taking the initiative to provoke a war.

b. Having the initiative also means that Nongfu Spring has sufficient discretion over the start and end of the war. According to some channel surveys seen by Dolphin, this one-yuan water war should end around the time of the National Day holiday, and by the end of July, to offset the impact of the war, the ex-factory price of the 19L large packaged family drinking water has already been raised by 20% in some regions.

c. Naturally, one can imagine that when the war ends, through this one-yuan water war, Nongfu Spring, with the slightly reduced price of the green bottled water, will re-enter the purified water market to compete for a portion of Yi Bao's market share in the purified water track. There is also hope to open up some new space for the mineral water business, which was originally facing growth bottlenecks. Of course, in this process, the unit price may also have to make some sacrifices.

With the sugar-free tea beverage business, which has a higher ceiling and growth potential than the water beverage, in hand, Nongfu Spring's growth prospects remain promising.

Looking ahead, with the recovery of packaged water revenue and profit, and the continued growth potential of tea beverages, despite the repeated valuation and performance hits, in Dolphin's view, the company's logic remains intact, and the actual valuation logic is not easy to break down.

Therefore, after the valuation of Nongfu Spring fell to 25 times PE ratio, the once unattainable Nongfu Spring has actually provided an opportunity for ordinary investors to climb up.

Of course, if Nongfu Spring's performance can be smoothly restored, besides being very friendly to investors, Zhong Xin should be able to breathe a sigh of relief, as the position of the richest man is unlikely to fall on his head, and the pressure will smoothly transfer to Zhong Tan Tan!

Nongfu Spring Product Matrix

Below is a detailed interpretation of the financial report:

I. Overall Performance: Packaged water drags down revenue significantly

A series of events have led to a significant negative growth in the packaged water business, dragging Nongfu Spring's overall revenue directly from 33% in the second half of last year to 8.4% now, seemingly making the "Water Maomei" brand name just a facade.

II. Packaged Water: YoY -18%, the pandemic didn't even hit this hard

Due to the public relations events at the beginning of the year, coupled with the water wars in the middle of the year, packaged water revenue was only 8.5 billion RMB, with a year-on-year growth rate plummeting from 10% in the second half of last year to -18.4% now, much more severe than the market's expectation of within 10% revenue contraction.

As the industry leader of a counter-cyclical necessity product, how did Nongfu Spring achieve a -18% decline in packaged water revenue?

a. After the Spring Festival, the founder of Wahaha passed away, triggering online criticism of Nongfu Spring, from Zhong Shantang's character, to his family's nationality, and then to the criticism of the Japanese-style packaging design of Nongfu Spring, ultimately leading to stagnant online sales of Nongfu Spring, reduced display of Nongfu Spring in some offline stores, forming the first wave of impact;

b. The second wave was clearly Nongfu Spring actively initiating a one-yuan water war under the public opinion turmoil. "From the same natural water, with a sweeter taste," the 550ml green bottle Nongfu Spring "Purified Water," with a more thorough filtration method, was launched, with a factory price 20% lower than the red bottle, sparking this year's drinking water war.

PS: Many people may not know the difference between mineral water and purified water. Generally speaking, the water source of mineral water comes from underground springs, lakes, and other underground or surface water sources, while the term "mineral" mainly refers to the retention of minerals in the water.

Purified water comes from many sources of urban water supply, although Nongfu Spring claims that its green bottle purified water comes from natural water sources. Why did Nongfu Spring, which has always focused on "healthier" mineral water, start to introduce purified water?

In terms of timing, packaging, and advertising slogans, no matter how you look at it, it seems like Dolphin Jun is targeting its competitor Yi Bao's listing with a direct confrontation and proactive provocation.

In other words, excluding the wave of online criticism at the beginning of the year, the main reason for the significant drop in revenue this time seems more like Nongfu Spring facing a bottleneck in the gradual growth of natural water revenue, taking advantage of the opportunity when competitors are going public to expand into the relatively incremental pure water track for themselves.

Furthermore, following this line of thinking, actively deteriorating the revenue from bottled water. In other words, compared to the normal industry stock, the increasing number of competitors and intensifying competition, the passive dragging down of industry leaders (such as in the e-commerce industry), Nongfu Spring seems more like taking the initiative to drag down its own business in an "active attack" style of business warfare, rather than a real deterioration of industry competition.

III. Tea Beverages: Remaking Nongfu Spring

Originally, Nongfu Spring stated that reaching 10 billion in revenue is a watershed for soft drinks, and growth dividends are likely to slow down after that.

However, looking at the tea beverages that have been bucking the trend in the first half of the year, with the help of Tea π on the left hand and Eastern Leaves on the right hand, tea beverages achieved close to a 60% year-on-year growth, rivaling packaged water.

In terms of profit, the 3.7 billion profit from tea beverages vs the 2.7 billion profit from water beverages, a 44% profit margin for tea beverages vs a 32% profit margin for water beverages, tea beverages have not only helped Nongfu Spring significantly but have also become a major contributor to its revenue!

Moreover, the key issue is that under such a volume, its growth and profitability are much stronger than packaged water, so after stepping out of the drinking water battle, Nongfu Spring can still have decent growth thanks to tea beverages.

IV. Juices and Functional Beverages Need More Time

Compared to tea beverages, the performance of functional beverages and fruit juice beverages is relatively average. There are ups and downs compared to market expectations, but because of their small business volume, they do not have a significant impact on overall operations.

One of these businesses focuses on the growth segment of functional beverages, while the other emphasizes the freshness of raw materials and processing technology. Currently, they are showing some growth in small volumes but have not fully developed. Especially for fruit juice, compared to the first three businesses, the profit margin is much lower due to high raw material costs.

V. Water Battle Drags Down Gross Profit

Engaging in a price war for essential goods with low unit prices, even with the decrease in prices of corrugated paper and PET materials, it is difficult to maintain gross profit margins. In the first half of the year, due to the intense competition in packaged water, Nongfu Spring's gross profit margin was significantly dragged down, falling to 58.8% in the first half of the year, with both quarter-on-quarter and year-on-year declines in gross profit margin.

The market's original expectation was that, due to the active and passive increase in the high-margin tea beverages, the company's overall gross profit margin would at least show some improvement quarter-on-quarter, with the market generally expecting around 59%-59.5%

Moreover, from the perspective of operating profit structure, businesses with high sugar content like fruit juice beverages seem to have experienced a noticeable decline in profits due to the slight increase in prices of sugar and the fact that raw materials such as fruits were not in season.

VI. Shuimao also starts to focus on internal profitability

Fortunately, the main impact of the bottled water war is on gross profit margin. In terms of expenses, especially the largest expense of marketing, Nongfu Spring's expenditure remains relatively restrained.

Compared to the total revenue growth of over 8%, the total expenses for sales and administration (including R&D) only increased by 4% year-on-year. Particularly in terms of nature expenses, there was a direct negative growth of 5%. Amidst the decline in gross profit margin, by controlling internal expenses, some operating profits were squeezed out additionally.

In the end, with packaged water slightly underperforming in terms of overall revenue and dragging down gross profit margin, Nongfu Spring managed to achieve a basic pass in terms of core operating profit (revenue - cost - three expenses) that Dolphin Jun pays close attention to, as well as the net profit on the company's financial statements, slightly exceeding market expectations.

The main operating profit was 7.148 billion, slightly exceeding the market expectation of 7 billion.

Longbridge Dolphin Research "Nongfu Spring" Historical Articles:

Financial Reports Season

August 25, 2022 Financial Report Review "Nongfu Spring: Tea Beverages Surging Against the Trend, Can 'Shuimao' Hold Back in the Second Half of the Year?"

August 25, 2022 Conference Call "Tea Beverage Products Become a New Growth Point"

March 30, 2022 Conference Call "Nongfu Spring 2021 Annual Performance Exchange Meeting Summary: Sales Targets Basically Achieved"

March 28, 2022 Financial Report Review "Nongfu Spring: The Return of the 'Shuimao' King"August 25, 2021 Financial Report Review "Nongfu Spring: The Return of the 'Water King', but Valuation Risks Cannot Be Ignored"

March 29, 2021 Conference Call "Nongfu Spring 2020 Performance Conference Call Summary"

March 26, 2021 Financial Report Review "Nongfu Spring: Has the Performance Been 'Watered Down'?"

In-depth

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

July 14, 2021 "Nongfu Spring (Part 1): Tell a Story of 'Source' Thinking in Drinking Water"

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

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