Incident: The company released its semi-annual report for 2023. In 23H1, it achieved revenue of 2.59 billion yuan, an increase of 26.8% over the previous year, recorded an adjusted net profit of 70 million yuan, an adjusted net profit margin of 2.7%, and a loss of 250 million yuan for the same period last year.

Revenue grew steadily, and profits turned losses into profits. 1) Revenue side: By business line, revenue from freshly made tea/baking/bottled drinks/other products was +29.4%/-3.8%/+83.8%/+55.6%, respectively, to 19.0/3.7/16/ 170 million yuan; in terms of brand performance, Naxue's tea/bottled drinks/table cover/other revenue was +25.3%/+83.8%/-24.1%/+31.5% of 23.5/1.3/0.5 billion yuan, respectively. 2) Profit side: 23H1. The company's adjusted net profit margin and Nai Xue's tea and beverage shop operating profit margins were 2.7% and 20.1%, respectively, compared to -12.2% and 10.4% in the same period last year. 3) Cost side: 23H1 The company's labor costs and depreciation costs for right of use assets were significantly optimized. Material costs/employee costs/depreciation of used assets, advertising expenses, and distribution service charges accounted for 31.8%/26.4%/7.7%/2.9%/7.4%, year-on-year, +0.1 pp/-8.4 pp/-3.1 pp/-0.8 pp/-0.6 pp.

“Direct management+franchise” two-wheel drive, stores are expected to continue to be encrypted. At 23H1, there was a net increase of 126 stores in Naxue compared to the end of the 22nd, bringing the total number of stores to 1,194. Among them, Class I and Class II stores reached 975/219, with a net increase of 79/47, respectively. First-tier, new first-tier, second-tier, and other urban stores accounted for 35%/34%/22%/9%, respectively. Furthermore, according to the company's announcement, the company officially started the franchise business on July 20, 2023, and is expected to open the first batch of Nai Xue partnership stores on 23H2. We believe that while focusing on the high line through directly managed stores, the brand will further penetrate the low line through partner stores, increase store density, and increase brand market share.

The profitability of stores has increased, and operating cash flow has improved dramatically. 23H1. The company continues to optimize the supply chain and improve human resource efficiency and rent bargaining power. The share of raw materials/manpower/actual rent/takeout expenses/utility expenses/other depreciation and amortization of a single store was 29.6%/19.6%/14.4%/8.0%/2.7%/5.6%, respectively. The store operating profit margin was 20.1% (achieving the short and medium term target of 20%), a significant increase of 9.7pp over the same period last year. Net cash income from operating activities was about 4.1 billion yuan, a sharp increase of 296.1% over the same period last year.

Innovate brand marketing and launch cost-effective products. 23H1. The company has collaborated with various IPs such as Donga Ejiao, Little Prince, Martial Arts Gaiden, and SpongeBob SquarePants. The main drinks are basically in the 9-19 yuan price range. We are committed to being tasty and not expensive, and to meet the real needs of consumers to cover more customer groups. As of 23H1, the average daily order volume of Nai Xue's tea drinking shop increased 5.0% to 363.4 orders over the same period last year.

Profit forecast and rating: Nai Xue, as a leading brand of freshly made tea drinks, is expected to drive rapid store expansion and continued growth in profitability. We expect the company's net profit from 2023-2025 to be 2.3/48/82 billion yuan respectively, giving the company 22 times PE in 2024, corresponding to a target price of 6.16 yuan, or HK$6.62 (exchange rate: 1 HKD = 0.93 CNY), maintaining a “buy” rating.

Risk warning: Risks such as store expansion falling short of expectations, food safety issues, and increased competition in the industry.