Report summary

Core view: Our research found that excellent consumer goods companies mainly have two styles of play. One is a differentiated style of play, focusing on product and system design; the other is an efficient and low-cost style of play with high efficiency everywhere. We think Nongfu Spring focuses more on the former. Many reports explain more that the company's strategic positioning and channel marketing are excellent. In our opinion, Nongfu Spring's design capabilities are worth paying attention to. From a value chain perspective, Nongfu Spring's sub-industries such as water, tea, beverages, and juice are actively expanding upstream. The selection of raw materials is relatively closed and differentiated, and manufacturing differentiates midstream design, technology, publicity, etc., to build minimalist products, promote health, and return to the essential characteristics of the products. Downstream application scenarios are extensive, product compatibility is very good, and it is easy to create large products. We believe that in the midst of a wave of consumption upgrading, Nongfu Spring can still have good room for growth in the next 3-5 years through high-quality products and fission of products. Coupled with the decline in channels, Nongfu Spring will still have good room for growth in the next 3-5 years.

There is room for a 2.6-fold increase in per capita consumption of packaged water compared to the US. Packaged drinking water has plenty of room to grow. The long-term ceiling depends on consumers' trust in tap water systems, and it is difficult for water purifiers to replace packaged water. 1) There is no substitute for the portability of small to medium packages of drinking water. 2) Consumers are concerned about the direct drinkability of wastewater and filtered water from water purifiers.

3) Water purifiers in developed countries are technologically advanced and have high penetration rates, but incidents such as serious water pollution and natural disasters will hurt consumers' confidence in tap water, leading to explosive growth in packaged water sales. Due to the high quality of tap water in Japan and the UK, China's per capita drinking water consumption should be compared to the US, and there is room for a three-fold increase.

The trend of improving the structure of packaged water is clear. The total terminal sales volume of the packaged drinking water market in China is about 240 billion dollars, and the 2015-2020 CAGR was about 9%. Unit prices are rising steadily, and there is room to double compared to developed countries. Upgrading from pure water to natural water: We expect the proportion of pure water to decline at an accelerated pace in the future. The trend of upgrading from pure water to natural water is clear. Combined with direct product price increases and high-end product segmentation, it will drive unit prices up over the long term. 1) According to international experience, after the safety level of drinking water increases, the consumption demand for packaged water will shift from safe to healthy, leading to an accelerated decline in the proportion of pure water; 2) Natural water and natural mineral water are more in line with the general trend of food and beverage health, and the growth rate in recent years is significantly higher than pure water. Consumer demand for high-end packaged water is escalating: the trend of high-end industry is gradually showing, and high-end water is growing faster than the industry. The packaged water market is highly concentrated and is expected to increase further in the future.

Sugar-free teas and NFC juices are leading the structural upgrade of the tea beverage and juice industry. Packaged tea drinks: Currently, sugar-free tea accounts for only 5%. After years of market cultivation, we have ushered in a period of rapid development, with a compound growth rate of over 30% in the past 5 years. Sugar-free tea accounts for over 80% of the ready-to-drink tea market in Japan. China's long-term share of unsweetened tea is on par with Japan's. Juices: A shift from sales growth to price driving is expected. NFC juice accounts for 5% in China. Assuming that the overall juice sales scale in China does not change in the future, it can be estimated that the NFC industry space is 175 billion by reference to the share of NFC in the US.

Nongfu Spring: Building barriers in the middle and upper reaches to create a “natural” drinking system from the top down. Upstream control of high-quality raw materials: high-quality mineral water resources are limited, approval of water intake rights is being tightened, and first-mover companies have already carried out some development and utilization, combining the asset-heavy model to form upstream barriers. Decades of accumulation have enabled the company to achieve a nationwide layout of high-quality natural water sources, effectively shortening transportation routes, and enabling the company to sell natural water for up to two yuan and still be profitable. Modern orchards and tea plantations built from 20 years of agricultural experience guarantee outstanding product quality from the source. Midstream focuses on R&D, has strong product design capabilities, and is guaranteed by independent processing capabilities. Backed by health centers, basic R&D and applied R&D are placed equal emphasis, and R&D investment is high.

Nongfu Spring is good at judging consumer market trends and making forward-looking arrangements, differentiating itself from mainstream products in terms of raw materials, processes and packaging, and continuously improving products with advanced technology. Oriental leaves, NFC juice, and charcoal coffee will lead and benefit from structural upgrades in various categories, and will overtake every corner with outstanding product strength under the health trend. Downstream products are affordable, highly compatible, and have a wide range of application scenarios: The company reduces costs through upstream and midstream accumulation, so that high-quality products can be consumed by the public. For example, NFC juice has a significant price advantage over competing products. The product is suitable for a wide range of people and scenarios, and is highly resistant to risks. Nongfu Spring uses advertising fees efficiently, and the advertising expenses rate is significantly lower than that of comparable companies. The actual results achieved by limited advertising investment are good, gross sales spreads are superior to comparable companies, and product brand strength is leading.

Profit forecasts and investment advice: The company is a leader in the packaged water industry, with both certainty of growth and scarcity of targets. Considering that the industry where Nongfu Spring is located has very broad room for growth, the product audience is the vast majority of consumers, and the application scenarios are also very broad, so compared to comparable companies, it has stronger long-term growth and risk resistance, and a certain valuation premium should be given. We expect the company's revenue for 2021-2023 to be RMB 273.92, 322.16, and RMB 375.65 billion respectively, up 19.73%, 17.61% and 16.60% year-on-year. The net profit attributable to the mother is 60.87, 74.10, and 8.799 billion yuan, up 15.34%, 21.74%, and 18.74%, EPS is 0.54, 0.66 and 0.78 yuan respectively, and the corresponding PE is 68X, 56X and 47X respectively. The first coverage gave an “increase in holdings” rating.

Risk warning: Risk of brand or reputation damage, risk of repeated epidemics, risk of fluctuations in raw material prices, risk of not being able to meet changes in consumer demand, risk of changes in valuation logic of comparable companies, risk of information being delayed or not updated in a timely manner