Incident: The company released its 2023 annual report. The company achieved revenue of 5.164 billion yuan, a year-on-year increase of 20.3%; achieved adjusted net profit of 121 million yuan, turning a year-on-year loss into a profit.

Explore franchise and overseas growth opportunities, and expansion is expected to accelerate under the small-store model. In 2023, the company had a net increase of 506 direct-run stores, and the number of stores reached 1,574 at the end of the period. In late July 2023, the company liberalized the franchise model. As of February 2024, about 200 franchise stores were opened, mainly in middle- and low-tier cities. Furthermore, the company opened its first store in Thailand at the end of 2023 to explore overseas growth opportunities. In February 2024, the company optimized the requirements for franchisees, made the store more flexible, reduced the initial investment cost requirements, and the franchise business is expected to grow rapidly.

The price war puts pressure on single-store sales, and adjustments to the single-store model drive an increase in store profits. In 2023, high-end tea brands concentrated on price adjustments to meet consumer demand. Daily sales in first-tier, new first-tier, second-tier, and other cities were -11.8%/-16.7%/-13.5%/-18.5% respectively. Customer unit prices declined in 2023, but raw material costs were relatively stable, and the company introduced automatic tea machines and automatic scheduling machines, which greatly optimized the ratio of labor costs to revenue, and the store's profit margin increased to 17.7% from 11.9% in 2022. Demand side pressure is still present in 2024, but we believe that the company will continue to promote product innovation, reduce costs and increase efficiency, improve single store efficiency, and maintain store profit margins.

Investment advice: The company continues to optimize the single-store model, open the franchise model to penetrate the sinking market, and profitability is expected to rise steadily. We expect the company to achieve net profit of 1.42/2.47/357 million yuan in 2024-2026, corresponding to PE 28.48/16.46/11.37x, respectively, and downgraded to an “increase in holdings” rating.

Risk warning: store expansion falls short of expectations; single-store sales fall short of expectations; recovery of optional consumption falls short of expectations