Investment highlights:

The pioneer of milk tea in a cup, the prototype for brewing and ready-to-drink two-wheel drive has appeared. In 2005, the company pioneered the launch of solid milk tea. With its first-mover advantage, aggressive advertising and marketing strategies, and intensive channel cultivation, it achieved rapid sales growth from 500 million yuan to 2 billion yuan from 2006 to 2010, and established the leading position in the brewed milk tea industry with a market share of more than 50% in 2012.

As the brewing industry gradually matured, the company focused on developing the second-growth curve beverage business. In 2018, it innovatively launched Meco juice tea in cups, and became a 1 billion yuan single product in the second year after launch. Under the impact of the epidemic, some ready-to-drink consumption scenarios have been hit. Combined with the company's lack of experience in the ready-to-drink business, Meco juice tea experienced a decline after sales peaked at nearly 1 billion yuan. In 2023, along with the adjustment of the epidemic prevention and control policy, the beverage consumption scenario was restored. The company became an instant drink sales center, independent of the brewing sector, recruiting full-time ready-to-drink dealers, increasing the coverage of key outlets, and promoting the construction of frozen displays. At present, the adjustment and recovery of the ready-to-drink business has begun to bear fruit. In 2023, ready-to-drink revenue increased by 41.2% year-on-year, accounting for about 25% of revenue, and the prototype of a brew+ready-to-drink two-wheel drive has emerged.

The cash-brewing dairy business has an excellent pattern and strong profitability. It continues to be “hematopoietic” for the second growth curve. After years of competitive selection of domestic brewed milk tea, the competitive pattern has basically stabilized. According to Nielsen data, since 2017, the company's market share has exceeded 60%, ranking first.

In 2017-2023, the company's brewing business basically maintained a high gross margin level of around 40%, which is the company's core source of profit. We expect the profitability of the brewing business to continue to improve in recent years as the cost of palm oil and large packs of powder declines, compounding the reduction in the company's advertising investment in the relatively mature brewing business. We believe there are still highlights in the brewing business in the future. 1) Product innovation: the company focuses on product innovation and launched the “fresh coffee principle” in 2023 to further explore the general brewing field; 2) Deep regional cultivation: the company still accounts for 44.26% of revenue in the East China market in 2023, while the market share in Northwest China, North China, and South China is only 8%/5%/4%. Currently, the brewing business is unevenly distributed, and there is still potential for further exploration on the channel side.

The second growth curve of the ready-to-drink business continues to grow, and profit improvements can be expected. The two major products that the company focuses on cultivating have strong highlights: 1) Fruit tea: The company is the pioneer of juice tea in cups, with a juice content of at least 25%, reaching 5 times the national standard. The original cup packaging makes consumers think of freshly mixed drinks, and is also more cost-effective than fruit tea in cups. The company currently focuses its marketing on student groups, and the outlets are mainly distributed in schools and surrounding areas. We believe fruit tea products have sales of nearly 900 million yuan in the future. Potential to break circles in crowds and scenes; 2) Frozen lemon tea:

Ready-to-drink lemon tea has been developed for many years, and many major single products have been created. Ready-made lemon tea shops have flourished in recent years, from Guangdong to the whole country, promoting consumer education in the category of frozen lemon tea.

The company launched “Lanfangyuan Frozen Lemon Tea” in 2022, a rapidly developing racetrack for card position frozen lemon tea. In 2023, the company carried out key promotions at the original outlets, with excellent sales performance. With the expansion of outlets in the future, it has the potential to become the next big single product. According to our estimates, the ready-to-drink business revenue can be profitable if it reaches a volume of about 1.6 to 1.8 billion yuan. In 2023, the company's ready-to-drink business achieved revenue of 901 million yuan, +41.16% over the same period. We expect that in 2024/2025, along with channel expansion, the company's ready-to-drink business is still expected to achieve high growth, and the point of profit improvement is gradually getting closer.

Equity incentives stimulate internal management vitality, and future reforms can be expected after personnel adjustments. In 2023, the company once again launched equity incentives to stimulate internal business vitality, and successfully achieve its goals in 2023.

In terms of personnel adjustments, in December 2023, the company appointed Mr. Yang Dongyun as the company's general manager and fully tied to professional managers through equity. Compared with previous personnel adjustments, which mostly involved the replacement of sales managers, the scope of authority and responsibility of this personnel adjustment was raised to the level of general manager, reflecting the greater determination of the company and the new management to reform. Looking ahead, the company's brewing business is highly profitable, providing the company with a stable cash flow. The ready-to-drink business is currently still being invested. After a year of refinement, the current ready-to-drink channel approach has improved compared to the past. In the future, under strong reform expectations, the ready-to-drink business is expected to be further straightened out. With the increase in ready-to-drink business expenses, the company can be expected to be flexible in the future.

Profit forecast and investment rating: The company's basic brewing market is stable, the second growth curve, the ready-to-drink sector has gained momentum, the prototype of two-wheel drive has emerged, the company attaches importance to incentives, and expectations for future reforms are strong. We adjusted the company's profit forecast. The company's revenue for 2024-2026 is 42.49/4.722/5.216 billion yuan, respectively; the estimated net profit to mother is 3.58/4.61/526 million yuan, respectively, +28%/+29%/+14%; EPS is expected to be 0.87/1.12/1.28 yuan, respectively, and the corresponding PE is 17/13/12x, respectively. Considering the continued expansion of the company's ready-to-drink business, we can expect a profit inflection point in this business, so we upgraded the company to a “buy” rating.

Risk warning: 1) The promotion of new products fell short of expectations; 2) the recovery of the brewing business fell short of expectations; 3) the rise in raw material prices exceeded expectations; 4) increased competition in the industry; 5) food safety issues, etc.