Nongfu Spring's 1H24 revenue increased by 8.4% YoY to RMB 22.17bn and net profit grew by 8.0% YoY to RMB 6.24bn, despite sales of packaged drinking water products plunging 18% YoY due to online rumours and intense market competition. Notably, tea beverage segment delivered robust growth of 50% YoY, more than offsetting the deterioration in water segment. Influenced by promotional activities and unfavourable raw material prices, GPM also dropped by 1.4ppts YoY in 1H24. While the newly launched purified water product exerts margin pressure in the short term, we believe it will help Nongfu Spring regain market share. We remain positive about the long-term prospects of Nongfu Spring, in view of its continuous product innovation and superior profitability. As evidenced by recent sales, we expect the price war in packaged drinking water industry to ease in 2025. Maintain BUY.
Key Factors for Rating
Nongfu Spring released lacklustre 1H24 results. Due to intense market competition, rumour attacks and subdued consumer sentiment, in 1H24, revenue increased by 8.4% YoY to RMB22.17bn, and NP grew by 8.0% YoY to RMB 6.24bn. By product category, the continued strong growth in tea beverage products (+59% YoY) more than offset the deterioration in packaged drinking water products (-18% YoY). The revenue growth of functional beverage products slowed down to 4% YoY while the juice beverage products recorded a robust 25% YoY increase, thanks to the return of classic products. The GPM dropped by 1.4ppts YoY to 58.8% in 1H24, mainly due to 1) promotion of the newly launched purified drinking water products, 2) rising share of fixed costs from lower packaged drinking water sales, and 3) price hike of raw materials for juice.
Launch of purified drinking water products to defend market position. While sales from packaged drinking water products increased 19% YoY in Jan- Feb, subsequent online rumours have curtailed the sales of this category dramatically over the following 4 months. To defend its market share, the company launched a purified drinking water product in large bundle with a lower price per bottle (RMB9.9/12 bottles) compared to its traditional natural water product, also with higher promotional efforts. Dragged by downward ASP, the OPM of packaged drinking water segment narrowed by 4.2ppts YoY to 32.2% in 1H24. According to the mgmt, Nongfu Spring began to regain market share sequentially in July and August, but expects the recovery of packaged drinking water to take some time. Thereby, we anticipate the company's margin pressure to linger in 2H24 and the fierce competition in packaged drinking water industry to only start easing in 2025.
Achieving full year target challenging. The full year guidance of delivering double-digit growth across all four major categories appears difficult to fulfill, in view of tepid sales performance of packaged drinking water products. We now expect the group's revenue to increase by 10% YoY in 2024, despite a projected 15% decline in packaged drinking water sales. Nonetheless, we remain optimistic about the long-term prospects of Nongfu Spring, given continuous product innovation, deep channel penetration, leading market position, and better-than-peers profitability.
Key Risks for Rating
Downside risks: (i) commodity inflation; (ii) deteriorated brand equity; (iii) unsuccessful launch of new products; and (iv) intensified competition.
Valuation
We revised down our 2024/25/26 core net profit forecasts by 4%/3%/3%, mainly to factor in lacklustre sales of packaged drinking water and weaker margins. Our new target price of HK$33.2 is derived from DCF with the following key assumptions: (1) WACC of 8.8% (previous: 8.5%), and (2) terminal growth rate of 3% (previous: 4.8%). Our TP is equivalent to 2024/25E P/E of 27.8x/24.0x.