The 2023 revenue and net profit of Nongfu Spring increased by 28% and 42% YoY respectively, surpassing our estimates by 8% and 18%, primarily driven by robust growth in tea beverages (+83% YoY). GPM also improved considerably by 2.1ppts to 59.5%, largely due to normalised raw material costs. We believe Nongfu's commitment to product innovation, low-tier city penetration and premium brand image will secure top-line growth in upcoming years, and a double-digit growth in 2024 is likely achievable. Despite intensifying competition in the tea beverage market, we maintain BUY given the company's leading market position and promising profitability levels.

Key Factors for Rating

Encouraging 2023 results boosted by tea beverages sales. Nongfu's 2023 revenue was up by 28% YoY to RMB42.7bn and NP increased 42% YoY to RMB12bn, beating our estimates by 8% and 18% respectively. The notable growth was mainly attributed to an 83% YoY surge in tea beverages sales, coupled with cost reduction from raw materials and optimised logistic arrangement. For all product segments, mgmt guided 2024 revenue to grow by double-digit, which we deem conservative considering company's continuous investment in brand image and deepening penetration in lower-tier cities. While the recent online rumour prompted the company to suspend its livestreaming activities, sales performance in Jan-Mar 2024 has met expectations since sales in traditional channels demonstrated resilience.

GPM reached record high in 2023. Nongfu's GPM climbed by 2.1ppts YoY to 59.5% in 2023, thanks to normalised raw material costs, particularly in PET, and benign utilisation rate of production base. Despite PET price ascended YTD in 2024, the company's raw materials sourcing cost stayed flattish YoY and mgmt. expect the group GPM to be stable in 1H24. In terms of profitability, mgmt. also cautioned that the record high NPM of 28.3% in 2023 is not sustainable and anticipate the long-term NPM to be 23-25%. Our projections indicate that NPM of around 26% could still be achievable in the next few years, factoring fluctuating raw material costs and increasing S&D expense.

Sugar-free tea beverage market competition will be intensified. With consumers' growing health awareness, Chinese sugar-free tea beverage market exploded in the last few years. While Oriental Leaf benefited the most from being an early entrant, many leading and emerging brands have introduced dozens of sugar-free tea products to capture the rising opportunity in the last 1-2 years, resulting in less consolidated competitive landscape. We deem the established customer loyalty, ongoing flavour innovation and continued market penetration will enable Nongfu's tea beverage segment to grow at ~20% CAGR in 2023-26E, slowed from 60% CAGR during 2019-23.

Key Risks for Rating

Downside risks: (i) commodity inflation; (ii) deteriorated brand equity; (iii) unsuccessful launch of new products; and (iv) intensified competition.

Valuation

The 2023 results have demonstrated Nongfu's stable earnings growth, cash generating capability, and steady dividend payments since IPO. With this regard, we changed our valuation method from P/E to DCF to better reflect its long-term value.

Our new target price of HK$48.8 is derived from DCF with the following key assumptions: (1) WACC of 8.5%, and (2) terminal growth rate of 4.8%. Our TP is equivalent to 2024/25E P/E of 39.6x/34.5x. (previous: 50x 2024E P/E)