Looking at the medium to long term, there is still plenty of room for improvement in China's per capita beverage consumption level and beverage market capacity. China Foods (00506HK) is authorized to operate Coca Cola series products in 19 provincial administrative regions of China, including 11 categories and 24 brands of products, including soft drinks, juice, packaged water, energy drinks, instant tea, coffee, etc. The company's sales scope covers 100% of cities, 100% of counties and more than 60% of townships within its operating area, with manageable business accounting for 90%. As one of the two largest bottlers for Coca Cola series products in mainland China, the company has a solid production capacity layout and distribution network, which will fully benefit from the expansion of the domestic beverage industry.

In the first half of 2022, despite an unfavorable macro environment, China's food revenue continued to grow against the wind. Among them, sales volume decreased by 4% year on year, while the average unit sales price increased 10% year on year, thanks to 1) factory price increases; 2) combination optimization, including product innovation; and 3) packaging structure upgrades. As a result, total revenue increased 6.0% year over year to RMB 11.894 billion. Gross margin came under pressure due to rising purchase prices of major raw materials and packaging materials, falling 2.7 percentage points to 36.2% year on year. The company's continuous measures to improve quality and efficiency and the corresponding reduction in advertising and promotion expenses in the first half of the year reduced the sales expenses ratio by 3.9 percentage points to 27.6% year-on-year. The adjusted profit before interest and tax/net shareholder profit increased 20.6%/19.0% year-on-year to RMB1,126 million/RMB481 million respectively, slightly exceeding market expectations.

By category: 1) Soft drink sales increased 4.9% year-on-year to RMB 9.035 billion, and the market share remained above 50%; the main driving forces included “less is more” (promotion of small packages made Coca Cola a big winner), steady growth in the “sugar-free” and “fiber+” series (first half of 2022:8% year-on-year increase, accounting for more than 10% of total soft drink sales), and successful launch of new products (such as “Starway Walking Cola”, sugar-free “Sprite”, new flavor “AH”! HA! ”). 2) Fruit juice sales increased 21.0% year-on-year to RMB 1,656 million, reflecting a better-than-expected recovery in domestic demand for traditional juice categories and “juice source” bubble juice products. 3) Packaged water sales fell 10.3% year over year to RMB 749 million. Market share declined further as it was still in a painful structural upgrade phase. 4) Ready-to-drink coffee recorded double-digit year-on-year growth, higher than the industry average. “COSTA” maintained its position as the second largest brand in major markets, while instant tea recorded a more than doubling increase, reflecting the remarkable results of its product innovation and marketing methods.

Looking ahead, we believe we can expect an increase in the number of units in revenue for the full year of 2022, as directed by management. Within the company's operating area, the acceptance of price increases for its main products by end customers exceeded market expectations. Furthermore, the channel profit distribution mechanism is stronger, and the company's price list and marketing management are expected to be fully empowered. The catalysts include favorable weather conditions or peak season sales exceeding expectations, and the trend towards precision in domestic epidemic prevention and control. On a profit level, we expect the company's gross margin to rise moderately from the fourth quarter of 2022 to 2023 due to marginal slowdown in cost impacts. We raised our earnings per share forecast for 2022-2024 to RMB 0.239 (+0.026) /0.260 (+0.018) /0.289 (+0.007), respectively. We suggest that investors pay due attention to the short-term recovery of consumption scenarios and the marginal rebound in domestic demand. They may also look forward to the “scissor dividend” and profit elasticity released by “unit sales price - unit cost” in the medium term, as well as the company's long-term competitive advantage in terms of brand value/product innovation and the execution ability of the governance team. Combining the current attractive valuation level of Chinese food products and dividend returns, we reaffirm the “buy” investment rating.