The market size of China's soft drinks industry is close to trillion yuan, which is one of the most spacious tracks in the required consumer plate, and the steady growth rate is sustainable. Increased per capita consumption and rising health awareness will bring long-term development opportunities for packaged drinking water, energy drinks, ready-to-drink coffee and other subcategories. Under the background of different growth rates of sub-categories, low consumer loyalty and scattered industry concentration, we believe that the leading enterprises with the comprehensive capabilities of products, channels and marketing are expected to win for a long time and further integrate the market.

Abstract

China is one of the largest soft drink markets in the world.According to Sullivan, retail sales in China's soft drinks industry rose 6.6 per cent to 991.4 billion yuan in 2019 compared with the same period last year, with a steady growth momentum from 2014 to 2019. Packaged drinking water is the largest segment of the soft drinks market, accounting for 20.3% of the retail scale of the soft drinks industry in 2019, with a market size of more than 200 billion yuan, and the proportion has increased year by year in recent years. At present, China's soft drinks market has formed a stable 6N pattern, with six major categories, including packaged drinking water, protein drinks, fruit juice drinks, functional drinks, carbonated drinks and tea drinks, accounting for 77.8% of the soft drinks market in 2019. We expect the soft drinks market to maintain steady growth, mainly due to increased consumption per capita and rising consumption.

The rise of natural health, the prelude to high-end.With the improvement of Chinese residents' income level and the rise of health awareness, consumers are more and more inclined to choose natural, healthy, sugar-free and non-added beverage products. Under the trend of consumption upgrading, we believe that the packaging drinking water industry is expected to benefit from the rising trend of household water packaging rate to maintain rapid growth, and the product structure is expected to further upgrade to natural (mineral spring) water; driven by no saccharification trend, mature categories such as tea drinks and carbonated drinks are expected to usher in a new round of development opportunities. The high concentration of fruit juice beverages and the penetration rate of NFC juice products are expected to continue to increase, and the development potential of subcategories is expected; instant coffee is still in the breeding period, and explosive growth is expected with the increase in demand and penetration of young consumers.

At present, the industry concentration is low.Due to the low threshold of the industry, the large leading share of a single category, the rise of emerging brands, the rise of new media and other reasons, the structure of China's soft drinks market is still scattered. According to Euromonitor, the CR5 of Chinese soft drinks was 34 per cent in 2019, below the average CR5 level of 65 per cent in the US, Japan, UK and South Korea. We believe that the integrated enterprises with multi-category operation in the soft beverage industry are expected to further integrate the market through internal diversification and extension expansion by virtue of stronger product life cycle management capabilities, sound distribution networks and abundant financial strength. However, considering that the current market competition is still fierce, the improvement of market concentration may still take a long time.

The comprehensive strength of both products, channels and marketing elements is the core competitiveness of the soft drink industry.China's soft drinks industry has been in a situation of full competition for a long time. We believe that the moat established in the soft drinks industry by relying on a single advantage is not stable, and it is difficult to continue to gain market share. We judge that the enterprises with comprehensive strength of product, channel and marketing in the current soft beverage industry are more likely to win and become the future leaders of China's soft beverage industry: 1) the product side: the R & D capability lays the foundation; the diversified product matrix should deal with the category life cycle risk; 2) the channel end: breadth, depth and strong management are indispensable. 3) Marketing: differentiation, accurate positioning of target groups and in-depth marketing is one of the key elements for beverage enterprises to achieve long-term success.

Risks: raw material prices fluctuate sharply, industry competition intensifies, demand is weak, and public health events are repeated.

China has a broad market for soft drinks.

China's soft drink industry has great potential for future growth.

China is one of the largest soft drink markets in the world. According to Sullivan, retail sales in China's soft drinks industry rose 6.6 per cent to 991.4 billion yuan in 2019 compared with the same period last year, with a steady growth momentum from 2014 to 2019. Sullivan expects China's soft drinks market to maintain steady growth from 2019 to 2024, with an average annual compound growth rate of 5.9%, mainly due to the accelerated pace of urbanization, rising disposable income and rising consumption.

Chart: the size of China's soft drinks market (2014 Mustang 2024e)

Source: Frost Sullivan, China International Capital Corporation Research Department

Packaged drinking water is the largest segment of China's soft drink market, accounting for an increasing proportion year by year. Sullivan divides soft drink products into 10 main categories, of which packaged drinking water accounts for the largest proportion, accounting for 20.3% of the soft drink market in 2019, with a market size of more than 200 billion yuan, and the proportion has increased year by year in recent years, followed by protein drinks and fruit juice drinks, accounting for 14.9% and 14.5%, respectively. At present, China's soft drinks market has formed a stable 6N pattern, with six major categories, including packaged drinking water, protein drinks, fruit juice drinks, functional drinks, carbonated drinks and tea drinks, accounting for 77.8% of the soft drinks market in 2019.

Chart: Chinese soft drinks market structure (based on product category sales)

Source: Frost Sullivan, China International Capital Corporation Research Department

Coffee drinks, energy drinks and packaged drinking water are growing the fastest. Among the main categories of soft drinks products, coffee drinks, energy drinks and packaged drinking water had the highest annual compound growth rate from 2014 to 2019, reaching 29.0%, 14.0% and 11.0% respectively, and packaged drinking water was the fastest growing among the top three categories. Sullivan expects this trend to continue until 2024, when coffee drinks, energy drinks and packaged drinking water will continue to grow faster than the average annual growth rate of the overall market, and packaged drinking water is expected to maintain the largest share.

Chart: growth trend of soft drinks industry segment in China

Source: Frost Sullivan, China International Capital Corporation Research Department

Consumption upgrading: the rise of natural health, the prelude to high-end

With the improvement of Chinese residents' income level and the rise of health awareness, more and more consumers tend to choose natural, healthy, sugar-free and non-added beverage products. In recent years, the growth rate of natural water, sugar-free tea, NFC juice and other healthy drinks has increased significantly. Under the trend of consumption upgrading, we believe that the proportion of high-end beverages is expected to continue to increase, and the slowing growth of tea, fruit juices and other categories are expected to usher in the subdivision track growth opportunities brought about by consumption upgrading.

Packaged drinking water: the proportion of natural (mineral spring) water continues to increase

Sullivan divides packaged drinking water into four subcategories: natural water, natural mineral water, purified drinking water and other drinking water. Among them, natural water and natural mineral water come from natural water sources and contain minerals or trace elements that are beneficial to the human body. Because of their health properties, the retail price of natural water and natural mineral water is usually 2 yuan or more per bottle, which is higher than that of pure water and other drinking water.

Chart: product classification of China's packaged drinking water market (2019)

资Source: Frost Sullivan, China International Capital Corporation Research Department; Note: market size and share data are 2019.

Natural mineral water is different from other types of bottled water. According to information from the European bottled Water Industry Association, consumers prefer natural (mineral spring) water to other types of bottled water, mainly because of specific mineral composition, guaranteed quality and special taste.

The growth rate of natural (mineral spring) water market is faster than the industry average. In recent years, the growth rate of natural water and natural mineral water has exceeded that of the whole packaged drinking water. According to Sullivan, retail sales of natural water and natural mineral water reached 24.8 per cent and 18.4 per cent respectively between 2014 and 2019, with the combined share of sales climbing from 15.7 per cent in 2014 to 25.9 per cent in 2019 and is expected to rise further to 31.3 per cent in 2024. We believe that natural (mineral spring) water will continue to outperform the entire industry because of its health properties.

Chart: the upgrading trend of consumption in China's packaged drinking water market

Source: FrostSullivan, China International Capital Corporation Research Department

Consumers are willing to pay a premium for natural (mineral spring) water. According to Euromonitor, NONGFU SPRING CO., LTD. (09633) has a dominant position in the industry. Companies in the natural (mineral) water market segment, such as NONGFU SPRING CO., LTD. and Bainyama, have grown faster in the past two years, reflecting a growing consumer awareness of drinking natural (mineral) water. In addition, the following picture shows that consumers are also willing to pay a premium for natural (mineral spring) water. The retail price of natural mineral water is between 3-12 yuan per bottle, while the price of pure drinking water is only 1-2 yuan per bottle.

Chart: comparison of different brands of drinking water

Source: Euromonitor, China International Capital Corporation Research Department; Note: retail sales refer to retail end-market sales; all retail sales and retail sales growth data are from Euromonitor; price information as of July 2020

Tea drinks & carbonated drinks: non-saccharification brings a new round of development opportunities

# 1 No saccharification tuyere has arrived

According to international experience, non-saccharification is the general trend of the beverage industry, especially in the carbonic acid and tea sector. With the increasingly serious problem of obesity, consumers' awareness of health and non-sugar continues to rise. From the experience of developed countries, non-saccharification is the development trend of the beverage industry: 1) Japan: the proportion of sugar-free soft drinks market has increased from 8% in 1997 to 49% (including bottled water); 2) Australia: during the 20 years from 1988 to 2018, among the important beverage categories, the proportion of non-saccharification sales has increased significantly; 3) the United Kingdom: the proportion of non-saccharification of major categories including carbonated drinks has increased from 2011 to 2019. In addition, as a result of the nationwide tax on sugar in soft drinks in the UK in recent years, the sugar content of soft drinks dropped rapidly by 28.1% between March 2016 and March 2020.

At present, the whole non-saccharification of soft drinks in China is in its infancy, and the non-saccharification rate is still low (regardless of bottled water). There is still a big gap compared with developed countries. According to the product attributes and drawing lessons from the experience of non-saccharification development of various categories of soft drinks in Australia, we believe that carbonic acid and tea are the two main categories of sugar-free beverage development. Compared with other categories, the saccharification of carbonic acid and tea can bring new development opportunities.

Chart: evolution of sugar-free proportion of beverages in various countries

DataSource: Ito Garden, MDPI, British soft drinks Association, China International Capital Corporation Research Department; Note: 1) Australia and the UK accounted for the proportion of sales, Japan accounted for the proportion of production; 2) the proportion of sugar-free drinks in the UK includes low-sugar proportion, the UK diluted drinks are "dilutables", including pumpkin and sugar water (Squashes & Syrups) and other drinks.

With the rise of the trend of non-saccharification in China, enterprises have laid out sugar-free tracks one after another. Considering the international trend of non-sugar, the major beverage companies have laid out this track ahead of time, but the early products have not been sought after by the market because of their early launch time and bitter taste. Until recent years, with the continuous education of consumers and the improvement of consumers' awareness of health and weight loss, the trend of non-saccharification of domestic beverages has gradually sprung up, and various beverage companies have added the layout of sugar-free tea and sugar-free carbonation track one after another. it includes not only traditional beverage companies, such as NONGFU SPRING CO., LTD., Unified, Kang Shifu, but also new entrants, such as Yuanqi Forest, Xi Tea, Yili, Tsing Tao Beer (00168) and so on.

Chart: launch time of major sugar-free products

Source: company website, Baidu, Inc. photo, China International Capital Corporation Research Department

The tuyere has arrived, and the speed of sugar-free drinks has increased significantly in recent years. Although the Coke Zero / PepsiCo Inc Zero series entered China as early as 2008 / 2009, the sales of Sugar-free Coca-Cola carbonated drinks were relatively stable in 2009-2017 and did not begin to rise significantly until 2018. In terms of sugar-free tea, thanks to NONGFU SPRING CO., LTD. 's efforts to educate consumers in the field of sugar-free tea, the sales of oriental leaves of his sugar-free tea products have been growing rapidly since 2015 and have maintained double-digit growth in the past five years.

Chart: percentage of sales of sugar-free cola carbonated drinks in China (2005 Mel 2019)

Source: Euromonitor Consulting, China International Capital Corporation Research Department

Chart: retail sales of Oriental leaves and compared with the same period last year (2011 Mustang 2019)

Source: Euromonitor Consulting, China International Capital Corporation Research Department

# 2 Development opportunity of non-saccharification of carbonated beverages

There is still much room for growth of sugar-free carbonated beverages in China. Compared with the proportion of sugar-free carbonated drinks sold in other countries / regions (the average of the United States / Japan / Western Europe / UK is 46.8%), the proportion in China is still relatively low, only 3.4% in 2019. In addition, the proportion of sugar-free carbonated beverages sold in other countries has continued to increase in the past 15 years, and the trend of sugar-free development is obvious. Compared with the trend of non-saccharification in Britain, Australia and Japan, we expect that non-saccharification will bring further opportunities for the development of carbonated beverages in China.

Chart: proportion of sales of sugar-free cola carbonated drinks in 2019

Source: Euromonitor Consulting, China International Capital Corporation Research Department

Chart: percentage of historical sales of sugar-free cola carbonated drinks in countries / regions

Source: Euromonitor Consulting, China International Capital Corporation Research Department

Non-saccharification has become the main growth driving force of carbonated beverage enterprises. Take Coca-Cola Company (KO.US) / PepsiCo Inc (PEP.US) retail sales as an example, which has achieved positive growth in the past few years. PepsiCo Inc's income growth at the end of the report is even more obvious, achieving double-digit growth in 2018 / 2019 and still achieving high single-digit growth (8 per cent) under the influence of 1H20 public health events. we believe that sugar-free products are one of the main drivers of growth. According to Chinese food, its sugar-free products have achieved double-digit growth over the past few years, accelerating against the trend under the influence of 1H20 public health events, with a year-on-year growth rate of 40-50 per cent. Considering that the per capita consumption of carbonated drinks in China is still much lower than that in other developed countries, we think that carbonated drinks are expected to usher in a new growth point due to the smooth progress of non-saccharification of the products.

Chart: Coca-Cola Company's retail sales and year-on-year

Source: Euromonitor Consulting, China International Capital Corporation Research Department

Chart: PepsiCo Inc's retail sales and year-on-year

Source: Euromonitor Consulting, China International Capital Corporation Research Department

# 3 Development opportunities of sugar-free tea

Sugar-free tea drinks are booming. Sales of sugar-free tea drinks have grown strongly since 2017, driven by rising consumer appetite for sugar-free products. Sugar-free tea drinks accounted for 5.2% of the overall tea beverage market in 2019, compared with 1.5% in 2014. The average annual compound growth rate of retail sales of sugar-free tea beverages in 2014 and 2019 reached 32.6%, significantly higher than that of sugary tea beverages (3%).

Chart: the trend of consumption upgrading in China's tea beverage market

Source: Frost Sullivan, China International Capital Corporation Research Department

There is still much room for improvement in the permeability of sugar-free tea. According to the MDPI paper, Australian sugar-free tea accounted for 44.4% of sales in 2018; according to the Japan soft drinks Association and our calculations, we believe that the proportion of Japanese sugar-free tea is as high as 83%. In China, sugar-free tea accounted for 5.2% of sales in 2019, considering that sugar-free tea has a higher ASP and is expected to account for a lower proportion of sales. Compared with Japan and Australia, we believe that there is more room for future growth of sugar-free tea in China, but whether it can be raised to the level of Japan or Australia depends on the development of health awareness and the further improvement of per capita income.

Chart: proportion of sugar-free tea in China to other countries (2019)

Source: MDPI, Japan soft drinks Association, China International Capital Corporation Research Department; Note: 1) Australia and Japan are sales / output ratio, Australia is 2018 data; 2) Japanese data are based on sugar-free tea accounting for 25% of soft drinks in 2012 and 30% of soft drinks in 2018.

Fruit juice drinks: high concentration products and the rise of NFC fruit juices

The product structure is upgraded to high concentration products. Low-concentration fruit juices accounted for 75% of the overall fruit juice market in 2019, while medium-concentration and pure juice market segments grew more rapidly, mainly due to the growing consumer preference for natural beverages. From 2014 to 2019, the average annual compound growth rate of pure fruit juice and medium concentration fruit juice reached 12.9% and 9.4% respectively, which was higher than the average annual compound growth rate of 0.4% of low concentration fruit juice. The rising trend of average price also reflects the high-end process in the fruit juice beverage industry. We judge that due to the healthier product characteristics of medium concentration fruit juice and pure fruit juice, it is expected to maintain a rapid growth trend in the future.

Chart: the trend of consumption upgrading in China's fruit juice beverage market

Source: Frost Sullivan, China International Capital Corporation Research Department

Pure fruit juice has a broad development space, short-term FC pure fruit juice development prospects or better. Compared with developed countries, the proportion of pure fruit juice (including NFC/FC pure juice) sales in China in 2019 is still very low, only 6.1%, while the average of the United States / UK / Japan is 56.1%. We expect that the proportion of pure fruit juice in China is expected to further increase in the future. At present, Chinese NFC pure juice ASP still has a significant premium over medium / low concentration fruit juices. We judge that the short-term development of Chinese NFC pure juice may still be restricted by high prices, so it is difficult to release in the short term. However, in the medium to long term, with the upgrading trend of consumption and the improvement of household consumption power, we expect the acceptance of NFC pure juice to increase. On the other hand, FC pure fruit juice has a short-term outbreak basis, and the direction of pure fruit juice to replace low concentration fruit juice remains unchanged. In addition, as a transitional product, we expect that the development prospect of medium concentration fruit juice is better than that of low concentration fruit juice.

Chart: fruit juice consumption structure (sales volume) in 2019

Source: Euromonitor, China International Capital Corporation Research Department; Note: NFC is "Not from concentrate", FC is "From concentrate", the same below

Chart: 2019 National Juice ASP

Source: Euromonitor Consulting, China International Capital Corporation Research Department

Packaged drinking water / ready-to-drink coffee / energy drinks may become a major growth sub-category in the future

Thanks to urbanization and the accelerated pace of consumption upgrading, China's annual per capita consumption of soft drinks has continued to grow steadily in the past 14 years, rising from 23.2 litres in 2005 to 62.1 litres, of which packaged drinking water is the main contributor. Per capita consumption also continued to rise, from 8.5 litres to 34.0 litres.

Chart: changing trend of per capita consumption of soft drinks and packaged drinking water in China

Source: Euromonitor Consulting, China International Capital Corporation Research Department

There is still a gap in per capita soft drink consumption between China and developed countries. At present, the per capita consumption of soft drinks in China is only 40.6% of the average of Japan and South Korea, and we believe that there is a basis for improvement in the future. We judge from three dimensions that the space for future growth mainly lies in the packaging of drinking water, instant coffee and energy drinks: 1) the per capita consumption accounts for the average proportion of Japan and South Korea; 2) category 2014-19 consumption CAGR;3) Japan / South Korea development experience.

► packaged drinking water: although it accounts for a higher proportion of the average consumption of Japan and South Korea, the consumption of CAGR in 2014-19 is also higher. In addition, in the past decade, packaged drinking water has also shown a high growth trend in developed countries.

► instant coffee: the average proportion in Japan and South Korea is very low. After the per capita GDP and urbanization rate of Japan and South Korea reach a certain level, the sales of ready-to-drink coffee grow rapidly.

► energy drinks: still maintain double-digit growth in recent years, energy drinks and sports drinks have a substitution effect. The average consumption of these two categories in China accounts for 30% of Japan and South Korea, which is lower than that of the whole (40.6%).

Chart: comparison of per capita consumption of soft drinks and subcategories among countries (2019)

Source: Euromonitor, China International Capital Corporation Research Department; Note: per capita consumption is based on "Total volume" data, including retail and catering channels

Household consumption is expected to be the main growth driver of packaged drinking water in the future.

The increase in packaging rate is expected to drive the growth of packaging water consumption. According to our estimation, the current packaging rate of drinking water in our country is only 7%, which is lower than that in other developed countries; at the same time, considering that tap water in other developed countries can be drunk directly, the packaging rate of water in our country is at a low level. We believe that with increased health awareness, consumers will tend to choose healthier packaged drinking water instead of tap water or boiled water.

Chart: packaging rate of drinking water in different countries (2019)

Source: Euromonitor, China International Capital Corporation Research Department; Note: 1) for the calculation of per capita moisture in each country, please refer to the following figure; 2) the water obtained from drinking fountains is counted in non-packaged water.

Chart: calculation of per capita daily / annual drinking water in each country (2019)

Source: dietary guidelines for Chinese residents, National Bureau of Statistics, European bottled Water Association, China International Capital Corporation Research Department; Note: 1) the data of daily drinking water in China are from the Dietary guidelines for Chinese residents. It is recommended that adults drink 1.5-1.7 liters of daily drinking water (actual drinking water); 2) the amount of drinking water in other countries is based on China and adjusted by body weight. 3) the average amount of water consumed by minors under the age of 15 is 71% of that of adults (calculated by the European bottled Water Association)

Household consumption is expected to be the main growth driver of packaged drinking water. According to Sullivan, household consumption of packaged drinking water, or medium-sized packaged products, grew at an average annual compound growth rate of 20% from 2014 to 2019, higher than that of ready-to-drink and office space consumption. Benefiting from the rising health awareness of consumers, packaged drinking water has gradually become a substitute for boiled water or recycled barreled pure water, as the first choice for household drinking and kitchen water.

Chart: ready-to-drink channels, home and office packaging drinking water consumption scale

Source: Frost Sullivan, China International Capital Corporation Research Department

Unlike American household consumption, small and medium-sized packaging and multi-bottle consumption has gradually become the mainstream, we expect that China's large packaging household consumption is expected to become the main driving force in the future, mainly because: 1) Chinese households consumed less packaging water in the past, mostly outdoor consumption scenes, while the United States has a very mature barreled water business; 2) large packaging water price ratio is higher; 3) the development of e-commerce drives large packaging water business. According to Tmall supermarket aquatic product sales Top10 products, the first two are large packaging water. We believe that convenience is an important factor for the development of large packaging water, which can be illustrated by the fact that the sales growth rate of large packaging water in grocery stores and convenience stores is much higher than that in shopping malls. We believe that with the development of e-commerce business, large packaging water is expected to achieve better growth.

Chart: Tmall supermarket Aquatic products sales Top10 products (April 2019)

Source: DT Finance, China International Capital Corporation Research Department

Chart: sales growth rate of various channels of 2L packaged water in China (2017)

Source: Nielsen, China International Capital Corporation Research Department

There is more room for large bags of water for household consumption. According to our calculations, assuming that the medium-and long-term packaging rate can reach 20% in the future, of which the large packaging ratio can reach 1x3, we expect that the annual consumption of packaged water in households will reach 48.1 billion litres, which is about double the total consumption of bottled water in 2019 (Euromonitor data, 47.4 billion litres).

Chart: measuring space for household consumption of water consumption in large packages

Source: dietary guidelines for Chinese residents, China Industry Information Network, China International Capital Corporation Research Department

High-quality catering channels improve the growth prospects of the packaged drinking water market. Apart from household consumption, we believe that the water demand from quality catering channels will also enhance the growth potential of packaging water consumption. For example, the first brand of Chinese fast food in mainland China (from Euromonitor), fellow-villager Chicken has partnered with NONGFU SPRING CO., LTD. since 2015 to use NONGFU SPRING CO., LTD. to make soup to highlight the quality of the food. Looking ahead, we believe that more restaurants may begin similar attempts to enhance the growth prospects of the packaged drinking water market. According to our forecast, if we assume that 1% of high-quality restaurants provide similar services, we estimate that the annual packaging water for catering will reach 49-5.9 billion litres.

Chart: fellow-villager chickens make soup with NONGFU SPRING CO., LTD. water

Source: Baidu, Inc. Photo, China International Capital Corporation Research Department

Chart: annual packing water of high-quality restaurants

Source: national Bureau of Statistics, iResearch Consulting, Euromonitor Consulting, China International Capital Corporation Research Department: note: the total number of consumer groups is 16-59 years old = 14 * 64% million; the rate of eating out is quoted from iResearch Consulting data, and the water consumption per person per meal is estimated for us (3L=2.5L food + 0.5L meal)

Ready-to-drink coffee is still in the early stage of market cultivation and can be expected in the future.

There is a broad market space for instant coffee. China's ready-to-drink coffee market is still in the early stage, and the per capita consumption in 2019 is only 0.3 liters per year, which is still a big gap compared with Japan and South Korea (24.8 seconds 7.3). In 2019, the scale of China's ready-to-drink coffee market is 10.6 billion yuan, accounting for a much lower proportion of soft drinks than Japan and South Korea. The soft drink markets of Japan and South Korea have experienced the rapid development of ready-to-drink coffee, and this trend will most likely be repeated in China.

Chart: historical market scale of ready-to-drink coffee in China

Source: Euromonitor Consulting, China International Capital Corporation Research Department

Chart: ready-to-drink coffee sales in various countries account for the proportion of soft drinks (2019)

Source: Euromonitor Consulting, China International Capital Corporation Research Department

The preference of young consumers and the infiltration of offline cities are good for the growth of coffee consumption market. The current coffee consumption shows two major characteristics: 1) according to the distribution of the stores of the three major coffee brands, the coffee consumption habits of consumers in first-and second-tier cities are relatively mature, while coffee consumption in third-and fourth-tier cities still needs to be infiltrated; 2) among consumers, people aged 18-24 consume the most coffee, and we think that the post-95 generation Z has higher penetration and dependence on coffee consumption than other groups. Therefore, we expect an increase in young people's preference for coffee, which is conducive to the medium-and long-term growth of the coffee consumption market.

Chart: distribution of stores of the three major coffee chains

Source: Talking data, China International Capital Corporation Research Department; Note: data as of April 2020

Chart: age distribution of coffee consumers (2019)

Source: Talking data, China International Capital Corporation Research Department

The accelerated cultivation of the market will bring the impetus for the future development of China's ready-to-drink coffee market. Different from the positioning of coffee shops, instant coffee mainly locates the functional requirements, which is in the consumption stage after the formation of coffee consumption habits; compared with coffee shops, instant coffee has the advantages of low price and strong accessibility. With a marked increase in the number of ready-to-drink coffee brands in China in the past two years, leading beverage companies have laid out the market and launched high-quality ready-to-drink coffee products, such as Master Kang's Starbucks Corp, NONGFU SPRING CO., LTD. 's charcoal coffee, Coca-Cola Company's Costa coffee and so on. We believe that with the launch of more high-quality ready-to-drink coffee brands, consumer cultivation is expected to accelerate. We expect that with the accelerated cultivation of the market, the increasing demand of young consumers and the infiltration into offline cities, China's ready-to-drink coffee market is expected to see explosive growth in the future.

Chart: comparison of ready-to-drink coffee and coffee shop models

Source: China International Capital Corporation Research Department

Chart: the number of ready-to-drink coffee brands in China has increased in the past two years

Source: official website of each company, China International Capital Corporation Research Department

The industry pattern is scattered, and comprehensive enterprises are expected to further integrate the market.

The degree of industry concentration is not high, and the competition pattern of sub-category is divided.

At present, the industry concentration is low. According to the data released by the National Bureau of Statistics, as of December 2019, there were 6083 enterprises in China's soft drink market, with a large number of participating enterprises. Due to the low threshold of the industry, the large share of a single category leader in the market segment, the rise of emerging brands, e-commerce and other new channels, the structure of China's soft drinks market is still relatively scattered. According to Sullivan, the total market share of the top five companies in 2019 was 30.9%.

Chart: a Survey of the Market pattern of China's soft drink Industry (2019)

Source: Frost Sullivan, China International Capital Corporation Research Department

The competition pattern of sub-categories is divided, and the degree of concentration has stabilized in recent years. The four major categories of carbonated drinks, energy drinks, instant coffee and instant tea have a high market concentration, with CR5 above 75%, of which the first two are more than 90%. In the whole soft drink industry, except for the relatively stable competition pattern of carbonic acid, the market competition in other sub-industries is still fierce. According to Euromonitor, the overall CR10 of soft drinks was 50% in 2019, and the concentration has basically stabilized in the past three years. The decline in concentration year by year from 2010 to 2017 is mainly due to a large decline in the market share of traditional market leaders such as Wa, Coca-Cola Company and Kangshifu, and the rise of cutting-edge brands. In the past three years, with the emergence of new leaders in the soft drinks industry such as NONGFU SPRING CO., LTD. and continued to gain market share, the overall concentration of soft drinks has basically stopped falling in the past three years, and we are optimistic about the prospect that the market share of the soft drinks industry will be concentrated to the leading enterprises with comprehensive strength in the future.

Chart: comprehensive brands in Chinese beverage market

Source: Euromonitor, China International Capital Corporation Research Department; Note: Euromonitor's bottled water category includes bubble water, functional bottled water (such as pulsating, screaming, etc.), non-carbonated bottled water, etc.

Industry concentration has become a long-term trend, and comprehensive enterprises are expected to continue to dominate.

Compared with developed countries, there is still room for integration in China's soft drink industry. According to Euromonitor, the average CR5 of the soft drinks industry in the US, Japan, the UK and South Korea in 2019 is 65 per cent, significantly higher than China's 34 per cent. The industries of packaged drinking water, fruit juice and sports drinks are also significantly lower than the international average, and there is still plenty of room for market integration in the future. While the concentration of other categories is basically close to the international average, that is, the concentration of the tea market is slightly higher than the international average, but compared with the most comparable Japanese market, there is still some room for improvement.

Looking forward to future market integration, the short-term market may still face fierce competition. We believe that the comprehensive enterprises with multi-category operation in the soft beverage industry are expected to further improve the market concentration through internal expansion and extension mergers and acquisitions by virtue of their stronger product life cycle management, sound distribution network and abundant capital. We look forward to the prospect of comprehensive enterprises gradually integrating China's soft drinks market in the future, but considering that the current market competition is still very fierce, especially in the beverage market such as Yili and Tsing Tao Beer, as well as the strong rise of emerging brands such as Yuanqi Forest, the improvement of market concentration may still take longer.

Chart: CR5 comparison of national soft drinks and subdivision industries in 2019

Source: Euromonitor Consulting, China International Capital Corporation Research Department

At present, comprehensive enterprises occupy a leading position in the soft drink industry. Among the top five in the soft drink industry, only the fifth Red Bull is a single category enterprise, while Coca-Cola Company, Wa, Kang Shifu and NONGFU SPRING CO., LTD. are all comprehensive enterprises with multi-category operation, and their growth path is to carry out multi-category layout after establishing advantages in a single category. Therefore, the first four have their own advantages, such as Coca-Cola Company is a carbonated drink, NONGFU SPRING CO., LTD. is packaged drinking water.

Chart: comprehensive brands in Chinese beverage market

Source: company announcement, Frost Sullivan, Zhejiang Merchant Magazine, China International Capital Corporation Research Department; note: 1) income refers to group income or beverage income in the company's financial statements; 2) for Coca-Cola Company China, we use China Foods Group income and Swire's beverage income in mainland China (both companies are Coca-Cola Company's only bottling partners in mainland China) 3) for Kang Shifu and Uni-President, we use its beverage income; 4) for Wa, its income data comes from the 2018 after-tax income provided by Zheshang Magazine; 5) the product sales portfolio data is 2019.

The anti-life cycle of single category companies is relatively weak, and integrated enterprises are more likely to integrate the market in the medium and long term. We believe that in the long run, integrated enterprises are expected to seize more market share and continue to integrate the Chinese market, mainly due to the large scale of China's soft beverage industry, including more than 10 sub-industries, each of which has its own law of growth and change. if you only face a certain market segment, you are more likely to face life cycle risks. In contrast, companies with business lines across the beverage sub-industry can resist life cycle risks in a sub-industry through business diversification.

In addition, when single-category companies are faced with competition from strong competitors, their ability to resist competitive risks is weaker than that of integrated enterprises. For example, as the market for tea and fruit juice has almost stopped growing since 2015, the market share of Kadobao, which relies on a single business of herbal tea, has fallen sharply (while Wang Laoji competes for the market of herbal tea). The market share of Huiyuan Juice, which relies on a single business of fruit juice, has also declined slightly.

Chart: year-on-year growth rate of sales in China from 2006 to 2019

Source: Euromonitor Consulting, China International Capital Corporation Research Department

Chart: share of Jiaduobao and Huiyuan in soft drinks market

Source: Euromonitor Consulting, China International Capital Corporation Research Department

Core competence: comprehensive ability of product, channel and marketing

Comprehensive ability is the core competitiveness of soft drink industry. China's soft drinks industry has a large scale, a scattered market, low consumer loyalty and low barriers to entry, and the market has been in a situation of full competition for a long time. We believe that the moat established in the soft drinks industry by relying on a single advantage is not stable, and the trend of continuing to gain market share is difficult to sustain. We judge that the enterprises with comprehensive strength of product, channel and marketing in the current soft drink industry have a better chance to win and become the future leader of China's soft drink industry.

Product: lay the foundation for R & D capability, diversified product matrix to deal with category life cycle risk

Each category of beverage has its own life cycle. The development of the global beverage industry basically starts with carbonated beverages. With the gradual maturity of carbonated beverages, other beverages continue to rise in the market, such as juice, instant coffee / tea, sports / functional drinks, bottled water, etc.; each category of beverage has its own life cycle. Taking the Japanese market which has basically experienced the development cycle of all the sub-industries of soft drinks as an example, the Japanese beverage industry has experienced the life cycle of carbonated drinks, fruit juices, instant coffee, sports-functional drinks, oolong tea, green tea, mineral water and so on. Carbonated beverages, fruit juices and instant coffee basically stopped increasing around 1970, 1980 and 1990, respectively. Compared with the consumption structure of Japanese soft drinks in 1980 and 1999, the market has changed from the parallel pattern of carbonated drinks and fruit juice to diversified pattern, and the category structure is more abundant. Therefore, in order to cope with the category life cycle, product diversification is the key for enterprises to maintain sustainable growth.

Chart: the development of Japanese soft drink industry-category life cycle

Source: Japan soft drinks Association, China International Capital Corporation Research Department; Note: the soft drink categories marked in each period are the main growth subcategories in this period.

Chart: consumption structure of Japanese soft drinks in 1980 (output)

Source: Japan soft drinks Association, China International Capital Corporation Research Department

Chart: consumption structure of soft drinks in Japan in 1999 (output)

Source: Japan soft drinks Association, China International Capital Corporation Research Department

Coca-Cola Company case: continuous research and development, product diversification is the key to deal with category cycle risk. Coca-Cola Company set up a Japanese branch in 1957. In the 60-year history of operation, Coca-Cola Company basically ranks first in the Japanese soft drink market. The core is that Coca-Cola Company Japan is facing the life cycle of different categories presented by the Japanese beverage market. The company persists in research and development and constantly launches market explosions, leading the market development. For example, after the launch of Georgia coffee in 1975, it cooperates with brand marketing and channel presentation. Become the number one brand in the Japanese ready-to-drink coffee market. Similarly, the company launched successively into sports drinks, namely tea, bottled water and other fields, diversified sources of income, and achieved Top3 market share in each segment. We believe that continuous product innovation and the establishment of a diversified product matrix are the core elements of Coca-Cola Company Japan's strong competitiveness.

Chart: Coca-Cola Company Japanese market category and product development

Source: Coca-Cola Company Japan official website, Euromonitor Consulting, China International Capital Corporation Research Department; Note: figures represent the market share of brands in their market segments

Chart: market share of Coca-Cola Company brands of Japanese soft drinks in 2019 (by sales volume)

Source: Euromonitor Consulting, China International Capital Corporation Research Department

Chart: Coca-Cola Company occupies a leading position in the major market segments of Japanese soft drinks in 2019 (by sales)

Source: Euromonitor Consulting, China International Capital Corporation Research Department

Channel: breadth, depth and strong management are indispensable.

Good channel system: both broad and deep, stack and strengthen management. The consumption scene of the beverage industry is more offline. According to Euromonitor, China's offline channels accounted for 96.6% of the total in 2019, so offline channels are particularly important for beverage companies. There are about 6 million beverage terminal outlets in China, which go deep into county, township and other low-line city markets, so a good channel system needs to have breadth and depth to improve terminal sales coverage. In addition, due to the wide distribution of sales points, the beverage industry generally adopts a multi-tier distribution system, which can infiltrate into China's vast third-and fourth-tier cities and township markets, while the multi-tier distribution system has higher requirements for channel management. therefore, the strong management of the channel can make the whole sales channel smooth and prevent the disorder market behavior such as fleeing goods and pressing goods.

Chart: beverage industry distribution model (2019)

Source: Euromonitor, China International Capital Corporation Research Department; Note: the channel share data are Chinese data.

Coke Coca-Cola case: Channel has become another key to being the number one soft drink in the world. After more than 130 years of development, Coca-Cola Company has built the world's largest beverage distribution system, selling Coca-Cola Company in more than 200 countries or regions. Through its meticulous management, it has penetrated into major channels, including supermarkets, convenience stores, retail stores and so on. In 2019, through its 225bottlers and its own bottling subsidiaries, the company covers 30 million sales outlets worldwide, covering about 60 per cent of the world's retail stores; in addition, the company also has 16 million freezer equipment.

Chart: Coca-Cola Company global channel system

Source: China International Capital Corporation Research Department, the company's official website

Chart: number of dealers and terminal outlets of Chinese soft drinks companies

Source: company announcement, Frost Sullivan, Zhejiang Merchant Magazine, China International Capital Corporation Research; Note: 1) for Coca-Cola Company China, we use China Food Group income and Swire's beverage income in mainland China; 2) for Kang Shifu and Uni-President China, we use its beverage income; 3) for Wa, its income data come from the 2018 after-tax income provided by Zhejiang Merchant Magazine. 4) the number of NONGFU SPRING CO., LTD. dealers is basically first-class dealers, and Kang Shifu's dealer data include its instant noodles and beverage business data; 5) the number of NONGFU SPRING CO., LTD. dealers and terminal sales points as of May 31, 2020. Kang Shifu and unified data as of 2019

Marketing: accurate positioning, deep marketing

There are many categories and fierce competition in the soft drink industry. How to achieve differentiation, accurate positioning of the target audience and in-depth marketing is one of the key elements for beverage enterprises to achieve long-term success. Most of the successful beverage brands at home and abroad constantly strengthen brand recognition and loyalty in the minds of consumers through accurate positioning and continuous in-depth marketing. Take NONGFU SPRING CO., LTD. as an example, NONGFU SPRING CO., LTD. established a strong brand in the field of packaged drinking water through continuous in-depth marketing, making its products ranked first in the market share of packaged drinking water for eight consecutive years from 2012 to 2019.

"NONGFU SPRING CO., LTD." accurate positioning, continuous in-depth marketing. For the "NONGFU SPRING CO., LTD." brand, the company has developed three major promotion theme series. We believe that different promotion strategies at different stages have gradually deepened NONGFU SPRING CO., LTD. 's brand strength, which is consistent with the brand pyramid model put forward by Chenatoni, a professor of brand marketing at the University of Birmingham. That is, the process of brand development from the outside to the inside is characteristics, interests, emotional returns, values, personality.

Diversification reaches consumers and deepens brand image. The company communicates through consumers in all aspects through advertising, bottle activities, variety show names, film and television placement, star endorsements, sports sponsorship, social media marketing and cross-industry cooperation. Through different forms of marketing activities, NONGFU SPRING CO., LTD. is not only promoting his brand, but also promoting his brand spirit. At present, "NONGFU SPRING CO., LTD." has become a symbol of China's quality of life and a super brand in China's packaging water industry.

Chart: NONGFU SPRING CO., LTD. 's deep marketing activities for packaged drinking water

Source: company announcement, company website, China International Capital Corporation Research Department

[case] Yuanqi Forest: accurate positioning, take the non-saccharification tuyere, 4 years after its establishment, the valuation is 14 billion yuan

The layout of sugar-free tea and sparkling water has successfully become a cutting-edge brand in the beverage industry. Yuanqi Forest was established in 2016 as a "sugar-free expert". In 2017 / 2019, it cut into the two high-growth categories of the beverage market-sugar-free tea and sparkling water, and launched "burning tea" and "Yuanqi water". With the image of "good-looking, healthy and delicious", these two products have become popular beverage products in the market in a short time, especially Yuanqi Water, becoming the TOP 1 of Tmall 618 beverage category in 2020. According to news reports, the company's sales reached 1 billion yuan in 2019, of which about 2x3 contributed to energy and water.[1]1H20's sales increased sharply against the trend, exceeding 800 million yuan. As of July 2020, the latest valuation of Yuanqi Forest has reached 14 billion yuan.

Take the non-saccharification tuyere to accurately locate the needs of young consumers. We believe that the core of the company's great success: 1) the company cut into tea drinks, carbonated drinks and other large categories, while sugar-free tea and sugar-free carbonic acid are in the market explosion period. 2) differential positioning-"sugar-free experts", "Japanese", "good-looking and delicious", etc., accurately locate consumer demand and successfully make products stand out; 3) accurately grasp the hot spots of concern of young consumers and brand building through social media marketing; 4) take the lead in cutting into convenience store channels with highly overlapping and high-growth consumer groups, and then gradually extend to online, merchant super.

Chart: a case study of Yuanqi Forest

Source: Baidu, Inc. Photo, China International Capital Corporation Research Department

Benefiting from the continuous brand building, Yuanqi Forest Beverage products have a good performance after being pushed to online sales, and 1H20 public health events have reversed the trend of strong growth. According to Amoy data, Tmall's online sales of Yuanqi forest beverage products have significantly exceeded the level of the same period last year since March.

Chart: Tmall's net sales of Yuanqi forest beverage product

Source: Amoy data, China International Capital Corporation Research Department