Investment highlights

Nongfu Spring has been pursuing the “dual-engine” development of drinking water and beverages. On one hand, it meets the daily drinking needs of consumers and on the other hand, it satisfies the diverse and personalized drinking demands of consumers. Diversified product varieties enhancing flexible product mixes has enabled companies and distributors to achieve differentiating advantages in different markets and channels, to improve scale of business, distribution efficiency and profitability.

The world's second largest packaged drinking water company

Nongfu Spring's packaged drinking water products include natural drinking water and natural mineral water. The company is the second largest packaged drinking water company in the world in terms of sales volume. It is also the only company, among the top 5 PRC packaged drinking water companies, that uses solely natural water to produce packaged drinking water, pledging "Every drop of Nongfu Spring has its source". In 2020, the company's market share of packaged drinking water in China reached 20.9% (in terms of retail sales value), which is 1.5 times that of the second largest player. In 2018, 2019 and 2020, the revenue generated from packaged drinking water products accounted for 57.5%, 59.7% and 61% of the company's total revenue, respectively.

Profitability is comparable to the strongest companies in the soft beverage industry around the world

Nongfu Spring's gross margin of 59.1% in 2020 is well ahead of its peers, Tingyi Holding Corp.(33.2%) and Uni-President(34.4%); and is comparable to Coca-Cola(59.3%), the No. 1 soft drink company in the global soft beverage industry. Net profit levels were also much higher than the average in the soft beverage industry in China and also globally over the same period, reaching 17.6%, 20.6% and 23% in 2018, 2019 and 2020. High profitability levels are expected to remain stable in the long term.

Nationwide sales network with in-depth market penetration and Quality Distributor

Nongfu Spring's sales network is nationwide, accounting for approximately 11% of the 22 million retail points of sale in China, covering a wide area and not limited to first and second tier cities. The Company has partnered with local distributors who have extensive experience in the distribution of soft beverage products, leveraging their financial strength, professional teams and facilities to penetrate the local retail network. Besides, the "Nongfu Spring" branded refrigerators installed at nearly 500,000 retail points of sale have particularly enhanced the Company's brand display and share of shelf, thereby boosting sales volume. The Company's annual evaluation and screening of distributors has helped the distributors to improve their business capabilities, so that the overall quality and business capabilities of the cooperating distributors have gradually stabilized and matured.

Company valuation

Nongfu Spring is the leader in the soft beverage industry, with a significantly faster growth rate than the industry average in all its product categories. In addition, fruit juice, tea beverage and functional beverage products are bringing new development focus to the company. With reference to the average valuation of the company in the past year, we give the company a minus 1 standard deviation target P/E ratio of 63x for 2022, and estimate the company's EPS for 2021/2022/2023 to be RMB 0.7/0.8/1.0. The target price forecast for 2022 is HK$64.59, which corresponds to PE ratio of 74.1x/ 63x/ 53.5x for 2021/2022/2023 respectively. The Company is given a “Buy” rating (initial coverage).

Risk factors

The recovery of COVID-19 might not be as expected and the price of raw materials might increase.

Company introduction

Pioneered in the domestic packaged drinking water market; succeeded in realizing a prospective strategy; becoming the representative brand in the soft beverage industry

The predecessor of NongFu Spring Co., Ltd., Xin`an River Yangshengtang Drinking Water, was established in September 1996 as the earliest packaged drinking water enterprise in China. In 1997, the company launched its first packaged drinking water product using water sourced from Zhejiang Thousand-Island Lake. Subsequently, it was transformed into a joint stock company and renamed as "Nongfu Spring Co., Ltd." in 2001. Various soft drink products have also been launched afterwards. With the insight of its experienced core management team, the Company caught the development trend of the industry and was able to make forward-looking plans to obtain water extraction and mining licenses for 10 high-quality water sources in China. In 2016, the Company acquired the business, farmland and associated assets of Otakiri Springs Limited, a bottled water production and sales company in New Zealand, to expand its overseas operations. After more than 20 years of development, Nongfu Spring has been established as a representative brand in the domestic soft beverage industry and become a leading enterprise in packaged drinking water and beverages in China. The company's distributor network covers more than 2.4 million retail points of sale and has a diversified product portfolio that includes packaged beverages, fruit juices, functional beverages and tea beverages, etc. According to a report by Frost & Sullivan, Nongfu Spring has led the packaged drinking water market in China for 8 consecutive years from 2012 to 2019. In terms of retail sales, the company also ranked among the top 3 in the domestic market for juice, functional beverages and tea beverages in 2019.

Farmer Shanquan dominated China's packaged drinking water market for eight consecutive years from 2012 to 2019, according to The Frost Sullivan report. In terms of retail sales, the company also ranks in the top three in terms of domestic market share in fruit juice drinks, functional beverages and tea beverages in 2019.

Industry analysis

Increasing health consciousness and urbanization bring about the rapid growth of China's soft beverage market

China is amongst the world's largest soft beverage markets, with a market size of RMB 991.4 billion in terms of retail sales value in 2019. "Health" has undoubtedly been the trend in recent years. Consumers has become more health-conscious and tend to buy beverages that are either beneficial or burdenless to their health. Coupled with the growing consumption power of Chinese consumers driven by the acceleration of China's urbanization process, consumers have shifted their focus from price to quality in product consumption. While the process of urbanization has promoted diversification of sales channels, consumption frequency has also increased. Taking into account of all the aforesaid factors, the size of China's soft beverage market is expected to grow with a CAGR of 5.9% aligning with the applied CAGR in the period 2014-2019. Among all the sub-categories under China's soft beverage market, coffee beverage, functional beverage and packaged drinking water are the 3 sub-categories with the highest compound annual growth rate in market size. They are expected to grow at a CAGR of 20.8%, 9.4% and 10.8% respectively, from 2019 to 2024.

The competitive landscape of China's soft beverage market is relatively fragmented. The top 10 players took up only 42.5% of the total market share in 2019, in which the leading advantage of the top 4 participants, including Nongfu Spring, is more significant, with an aggregate market share of 27.7% .

The growth of Natural water and Natural mineral water tops the market

Packaged drinking water has been the largest category in China's soft beverage market, reaching a market size of RMB 201.7 billion in 2019. It can be broadly divided into 4 sub-categories, namely: 1. Purified drinking water; 2. Natural water; 3. Natural mineral water; 4. Other drinking water. As purified drinking water is generally defined as water that does not contain minerals or trace elements, and water sources are not strictly regulated, it is naturally the largest category of packaged drinking water, accounting for 60.4% of the overall retail sales of packaged drinking water in 2019. On the other hand, Natural water and Natural mineral water are 2 fastest-growing packaged drinking water categories in recent years, stimulated by people's increasing health awareness and rising consumption power. They are expected to grow at a CAGR of 15.2% and 14.1% respectively, from 2019 to 2024, and reach a market size of 89.5Bn and 30Bn in 2024.

The packaged drinking water market in China is relatively concentrated. In terms of retail sales in 2019, the top 5 participants accounted for more than 50% of total market share, while the largest player, Nongfu Spring's market share was over 50% ahead of the second largest player.

Sugar-free tea beverage, natural pure juice, and functional beverage as newly booming markets

The market size of the tea beverage market in China was RMB 78.7Bn in 2019. Tea beverages are divided into 2 main categories : sugar-free tea beverage and sugar-sweetened tea beverage. The market size of sugar-sweetened tea beverages has always been much larger than that of sugar-free tea beverages, with retail sales value accounting for nearly 95% of the aggregate retail sales value of all tea beverages in 2019. Nevertheless, given that people are adopting a more healthy consumption habit, the market size of sugar-free tea beverage is growing rapidly, and is expected to increase to 12.3% in 2024.

The market concentration of the tea beverage market in China is relatively high., with CR5 accounting for more than 85% of the overall market share.

Juice beverage market in China had a market size of RMB 143.5Bn in 2019. Low-concentration juice (Juice concentration: 5%-29%) has always been the mainstream. Yet, people tend to choose natural products nowadays owing to their rising disposable income and health awareness. This has sparked the growth of the retail sales of pure juice (Juice concentration:100%) and medium concentration juice (Juice concentration: 30%-99%). It is expected that the growth rate will further increase in the future, and the market size will reach 160Bn and 158Bn in 2024, respectively.

Juice beverage market in China is relatively fragmented, with CR5 being only 25.1%.

Functional beverage market in China had a market size of RMB 111.9Bn in 2019. The sector mainly covers energy beverage, sports beverage, and nutritional beverage, with energy beverage being the largest segment, accounted for over 70% of total market share in 2019. Such 3 subcategories under China's functional beverage market are expected to grow at a CAGR of 9.7%, 9.6% and 7.6% respectively, from 2019 to 2024. The overall market size of China's functional beverage market is expected to reach 175.4Bn in 2024.

The functional beverage market in China is relatively concentrated. CR5 was 56.7% in 2019.

Company products

Dual-engine development enables diversification of products

Nongfu Spring is more than a brand that sells water. The company has been pursuing the “dual-engine” development of drinking water and beverages. On one hand, it meets the daily drinking needs of consumers and on the other hand, it satisfies the diverse and personalized drinking demands of consumers. Diversified product varieties enhancing flexible product mixes has enabled companies and distributors to achieve differentiating advantages in different markets and channels, to improve scale of business, distribution efficiency and profitability.

The world's second largest packaged drinking water company

Nongfu Spring's packaged drinking water products include natural drinking water and natural mineral water. The company is the second largest packaged drinking water company in the world in terms of sales volume. It is also the only company, among the top 5 PRC packaged drinking water companies, that uses solely natural water to produce packaged drinking water, pledging "Every drop of Nongfu Spring has its source". In 2020, the company's market share of packaged drinking water in China reached 20.9% (in terms of retail sales value), which is 1.5 times that of the second largest player. In 2018, 2019 and 2020, the revenue generated from packaged drinking water products accounted for 57.5%, 59.7% and 61% of the company's total revenue, respectively.

Strategically take the lead in developing water sources

Being the pioneer in discovering and utilizing China's top 10 natural high-quality water sources is one of the keys to the company's success. The water sources chosen by the company have undergone rigorous water quality monitoring, water replenishment inspections, and water feasibility assessments to ensure the long-term supply capacity and stability of packaged drinking water products. The 10 water sources obtained by the company are located in different regions of China which cover the entire national market supply, realizing economies of scale. Besides, by establishing production bases near the water sources, this prospective planning has enabled the company to effectively shorten the transportation radius, better control the logistics costs, and improve profitability.

Concern over the quality of tap water promotes the demand of household-consumption water

Nongfu Spring has introduced different sizes of packaged drinking water: from the original small-size packaged products (380ml to 750ml) to the medium-to-large-size packaged products (1.5L to 19L) launched in 2016 to meet various consumption needs. The demand for household-use drinking water has increased significantly in recent years as consumers have become more health-conscious and doubt about the quality of tap water. As a result, the revenue of medium-to-large-size packaged products suitable for household consumption increased from 2.21Bn in 2017 to 3.88Bn in 2019, with a CAGR of 33%, far higher than the 15% growth rate of small-sized products. The proportion of medium-to-large-size products in the total revenue also increased from 12.6% to 16.2%. The recent outbreak of COVID-19 has further promoted the penetration rate of household-use water, and it is expected that the growth will remain strong.

In addition, the Company has launched several packaged drinking water products targeting different consumer segments and scenarios during 2015-2019, including a premium line of natural mineral water in glass bottles, natural mineral water with sports bottle caps, natural mineral water with lithium to repair the nervous system, and sterile natural water for infants and young children. Such products help to explore a new customer base, thus, providing new growth points for the company.

Multi-category beverage products to multi-brand development

Nongfu Spring's beverage products accounted for approximately 40% of total revenue. The Company's beverage products have been launched in a variety of categories, including juice, tea beverage, functional beverage, coffee, soda, flavored beverages and plant-based yogurt products, etc. Being attentive to market trends and consumers` changing demands for beverages, Nongfu Spring adopts a multi-brand development strategy, whereby each beverage brand has its own unique market position, expanding the Company's sales scale.

Breakthrough launch of NFC juice products

Nongfu Spring's juice beverage products cover a full range of low concentration juice, medium concentration juice and not-from-concentrate (NFC) juice products.The company has made a breakthrough solving the technical problems about raw materials, freshness and aseptic filling and successfully introduced the NFC juice series. The products have better taste and are more nutritious than the concentrated juice currently available in the market. The Company's fresh fruit processing and juicing bases in Xinjiang Uyghur Autonomous Region and Jiangxi Province, providing fruit raw materials for the production of NFC juice products.

Prospective strategic vision creates the No.1 brand of sugar-free tea

Nongfu Spring's 2 tea beverage series, "Teaπ" and "Oriental Leaf", are produced through an advanced aseptic cold filling process that preserves the original color, aroma and taste of fresh tea leaves. "Oriental Leaf", a sugar-free tea product strategically launched by the company, became the No. 1 brand in the sugar-free tea category with a market share of 3% in 2019.

A variety of flavors and nutritional formulas to meet consumer needs

The company's functional beverage products target customers who pursue a healthy lifestyle. The "Scream" series consists of 3 types of products, namely the fiber type, poly-peptide type and plant type, with different nutritional values and flavors to meet the health needs of different consumers. The six flavors in the "Victory Vitamin Water" series correspond to six different nutritional formulas.

New products on-line to seize the soft beverage market share

In addition to the above products, coffee beverage, soda water beverage, sparkling flavored beverage and plant-based yogurt products were launched in 2019 which further supported the Company to capture market share in the soft beverage market.

Competitive landscape

Profitability is comparable to the strongest companies in the soft beverage industry around the world

Nongfu Spring's gross margin of 59.1% in 2020 is well ahead of its peers, Tingyi Holding Corp. and Uni-President; and is comparable to Coca-Cola, the No. 1 soft drink company in the global soft beverage industry. Net profit levels were also much higher than the average in the soft beverage industry in China and also globally over the same period, reaching 17.6%, 20.6% and 23% in 2018, 2019 and 2020. High profitability levels are expected to remain stable in the long term.

Centralized procurement of raw materials to secure reserves at more competitive prices

As the cost of water is charged as resource tax, it is not significantly apportioned to individual bottles. Therefore, Nongfu Spring's gross profit margin is mainly affected by the cost of the raw material PET which accounts for approximately 30% of the Company's total cost of sales.

In order to reduce the impact on the Company's operations and profitability due to fluctuations in the prices and supply of raw materials, the Company maintains close cooperation with its raw material suppliers and centralizes its procurement in order to obtain more competitive purchase prices. The Company's PET purchase price is usually 5% lower than the national average price and will increase its reserves when the PET purchase price decreases to ensure the stability of raw material supply.

Sound R&D leads the company to prevail in the industry and to expand its market share

Nongfu Spring attaches great importance to invest in R&D, and through continuous research and development of new products, the company is leading the industry and expanding its market share. The company's R&D team currently consists of 106 technical staff, mainly responsible for application research, including the development of new beverage formulations, packaging design and process research. Among the R&D team, 62 team members hold a master's degree or higher qualification. At the same time, the technical support obtained through cooperation with relevant research institutes and universities has further strengthened Nongfu Spring's R&D capabilities. For example, basic research on beverages has been entrusted to the Yang Sheng Tang Institute of Natural Medicine. In 2011, the company took the lead in introducing the first aseptic production line for domestic beverage enterprises; successfully solved the problem of oxidation and discoloration of pure tea beverages and launched the first sugar-free tea beverage in transparent bottles in China; and developed the longest lasting preservative-free juice on the market.

World-leading production equipment + Highly stringent closed-loop enterprise quality management system

Nongfu Spring's production capability cannot be overlooked. The company has a highly stringent closed-loop corporate quality management system and world-leading production facilities. Its three main production bases has benefited from its efficient logistics network.

The company has established a closed-loop corporate quality management system covering the entire process, from quality control of raw material procurement, manufacturing process optimization, to storage and sales assurance. In order to regulate the quality of raw material suppliers, the company has standardized the admission criteria of raw material and packaging material suppliers, set up regular assessment and evaluation system. The production system of Nongfu Spring is also certified by the 3 main ISO quality management systems, while the storage, transportation and sales are monitored by the company's product assurance team and information traceability system. To date, the company has 12 production sites with 144 automated drinking water and beverage production lines, 7 fresh fruit juice production lines and 3 fresh fruit production lines. Among them, 17 drinking water production lines are capable of filling 81,000 bottles per hour and 14 beverage production lines are capable of achieving the Log6 aseptic standard. In addition, the company's 3 production bases, located in Qiandao Lake, Changbai Mountain, and Danjiangkou, are connected to dedicated railroad lines to ensure the efficiency and scope of transportation.

Brand preservation; high penetration

According to the 񓠄 Asia Brand Footprint Report" released by Kantar Worldpanel, Nongfu Spring is the No. 7 local FMCG brand in China, with 408 million consumer engagements and a year-on-year growth rate of 9.9%, the highest growth rate among the top 10 brands on the list. By category, according to Chnbrand's China Brand Power Index report, Nongfu Spring has been the No. 1 packaged water brand for 5 consecutive years since 2017, and its tea, juice and functional beverage sub-categories have also been ranked among the top 5 in the industry for years. Most of the company's beverage products have been able to maintain brand vitality for more than a decade.

Professional and healthy image built through in-depth and story-based brand advertising

Nongfu Spring has successfully established a "healthy and natural" image and conveyed the brand spirit through numerous simple and memorable classic advertising slogans. Among them, the most familiar slogans of the company are "Nongfu Spring tastes a bit sweet” and “We are not manufactures of water. We are porters of nature”. Under the theme of "Nature's Porters", the company has also launched a series of micro-films, telling short stories about the daily work of employees and the beautiful scenery of the Changbai Mountain water source, to demonstrate and promote the company's sense of corporate responsibility and the quality of water sources.

Diversified marketing methods to reach consumers in all aspects

The company has integrated online and offline marketing through advertising, bottle campaigns, variety show title sponsorships, product placement in movies and TV programs, celebrity endorsements, sports event sponsorships, social media marketing, and cross-industry cooperation. For example, the company changed the packaging of the “Victory Vitamin Water” and cooperated with programs such as The Rap of China and Idol Producer, which gave the product a new vitality and resulted in a CAGR of over 47% from 2017 to 2019. Many of Nongfu Spring's online and offline advertising campaigns have become classic marketing cases.

Nationwide sales network with in-depth market penetration and Quality Distributor

Nongfu Spring's sales network is nationwide, accounting for approximately 11% of the 22 million retail points of sale in China, covering a wide area and not limited to first and second tier cities. The Company has partnered with local distributors who have extensive experience in the distribution of soft beverage products, leveraging their financial strength, professional teams and facilities to penetrate the local retail network. In addition to selling Nongfu Spring's products in designated channels, distributors can also sell the Company's products in online stores or assign secondary distributors, if authorized by the Company, so that the Company can better expand the number of retail points of sale. Besides, the "Nongfu Spring" branded refrigerators installed at nearly 500,000 retail points of sale have particularly enhanced the Company's brand display and shelf space, thereby boosting sales volume. In order to control business risks and improve the operation level of their partner distributors, the Company utilizes the NCP system to conduct big data analysis to manage and guide distributors` inventory and product sales at the retail points of sale in real time. At the same time, the Company's annual evaluation and screening of distributors has helped the distributors to improve their business capabilities, so that the overall quality and business capabilities of the cooperating distributors have gradually stabilized and matured.

Direct business model helps the company consolidate its market position

Nongfu Spring has not only deployed its sales network in the form of distributor partnerships, but also has about 250 direct customers. The Company's direct customers are generally large customers, such as national or regional supermarkets, convenience store chains, e-commerce platforms, restaurants, airlines and group customers. By establishing business relationships with these customers, the Company can effectively increase product exposure, adjust its marketing strategy and control the direction of product development to strengthen its market position.

Developing new channels to expand the sales network

The soft beverage market has always been dominated by traditional channels (small grocery stores and non-chain convenience store) and modern channels (shopping malls, supermarkets and convenience store chains). About 80% of Nongfu Spring's revenue also comes from traditional and modern channels. However, emerging sales channels such as e-commerce channels are on the rise, with e-commerce channels alone growing at a much higher rate of 12.5% than traditional channels, and retail sales are expected to reach RMB 110Bn by 2024. On this basis, Nongfu Spring is actively expanding new retail channels represented by vending machines, with around 63,000 smart retail equipment installed in nearly 300 cities nationwide, providing consumers with an instant and convenient channel to purchase beverages and further expanding the company's retail points of sale.

Revenue Forecasts and Risk Factors

Revenue forecast

We forecast total revenue to be $31.4 billion, $35.0 billion and $39.2 billion from 2021 to 2023, respectively. 1) Packaged water business: Medium-to-large-size packaged water products will continue to expand due to the increasing demand for household-consumption water, driving revenue growth at a CAGR of 15.9% from 2020 to 2023. 2) Tea beverage business: the Company tops the sugar-free beverage market which is the development trend thus expects to bring about new growth point. The revenue is expected to reach $4,451 million in 2023, with a CAGR of 13% from 2020 to 2023; 3) Functional beverage business: the functional beverage market is one of the highest growth segments, and the Company's business will benefit from the overall growth of this market, with a CAGR of 24.1% from 2020 to 2023; 4) Juice beverage business: the Company will continue to focus on the development of NFC juice and is expected to gradually realize economies of scale, narrowing the raw material cost. The revenue is expected to grow at a high rate of 39.5% CAGR from 2020 to 2023.

Company valuation

Nongfu Spring is the leader in the soft beverage industry, with a significantly faster growth rate than the industry average in all its product categories. In addition, fruit juice, tea beverage and functional beverage products are bringing new development focus to the company. With reference to the average valuation of the company in the past year, we give the company a minus 1 standard deviation target P/E ratio of 63x for 2022, and estimate the company's EPS for 2021/2022/2023 to be RMB 0.7/0.8/1.0. The target price forecast for 2022 is HK$64.59, which corresponds to PE ratio of 74.1x/ 63x/ 53.5x for 2021/2022/2023 respectively. The Company is given a “Buy” rating (initial coverage).

Risk factors

The recovery of COVID-19 might not be as expected and the price of raw materials might increase.

* The analyst has a financial interest in the listed corporation covered in this report.

Financial data

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