Nongfu Spring (Minutes): Profits are high, margins are not essential

The following are the conference call minutes for Nongfu Spring's 2024 semi-annual financial report organized by Dolphin Research. For the financial report interpretation, please refer to "Nongfu Spring: Has the Nature Mover Stopped Moving?"

I. Core Information Review of the Financial Report

Sales and Distribution Expenses: The marketing expense ratio for 2024 decreased from 21.8% in the same period of 2023 to 21.4%. Although advertising and promotional expenses increased, logistics costs decreased due to the impact of the product sales volume structure.

Administrative Expenses: In 2024, administrative expenses amounted to RMB 1.962 billion, accounting for 4.6% of total revenue, a decrease of 0.5 percentage points compared to 2023.

Profit for the Year: In 2024, profit was RMB 12.123 billion, an increase of 0.4% compared to 2023, with a profit margin maintained at 28.3%, which is at the leading level in the industry.

Current Liabilities: The amount of current liabilities in 2024 was RMB 9.13 billion, mainly due to the increase in arrangements for term deposits of more than one year, and all long-term term deposits are freely convertible to cash.

Inventory Turnover Days: Increased from 55 days in 2023 to 82.3 days in 2024, mainly due to stocking up on seasonal agricultural raw materials.

Dividend Distribution: The board of directors approved the proposal to distribute a final cash dividend of RMB 0.76 per share at the 2024 annual general meeting, totaling approximately RMB 8.547 billion in dividends.

II. Detailed Content of the Financial Report Conference Call

2.1 Key Information from Executive Statements

Brand Challenges and Responses: In 2024, the company faced organized long-term smear campaigns and attacks online, putting its brand image to a historic test. In response to the crisis, the company clarified the facts through various means, including interviews with CCTV's dialogue program by founder Zhong Shanshan in August and December 2024, as well as a media exchange meeting in Ganzhou in November, sharing the company's continuous efforts in agricultural development, directly addressing controversies, criticizing internet chaos, and ultimately winning public praise, thereby maintaining a positive brand image.

Product Performance and Innovation:

(1) Packaged Drinking Water: Market share experienced a continuous decline for three months, with annual revenue down 21.3%, but it still holds the top position in China's packaged drinking water market. In April 2024, the company re-launched its purified water products, aiming to help consumers perceive the differences between purified water and natural water, along with corresponding advertising slogans; in December, a new 380ml packaging of Changbai Mountain natural mineral water was launched, and the packaging of natural water products was upgraded, using authentic images of the water source and ecological scenery to deepen the brand's natural health concept(2) Tea beverages: With excellent taste and quality, it achieved year-on-year growth of 32.3%, becoming a strong engine for performance growth. In 2024, Dongfang Shuye will return to the advertising campaign from its 2011 listing and will be frequently aired during the Paris Olympics; Teapai will launch a new flavor of jasmine lemon tea to enrich product flavors and specifications.

(3) Functional beverages: A year-on-year growth of 0.6%. In March 2024, JiaoQiang launched two new flavors: milk calcium type and tea amino acid type, adding JiaoQiang factors on top of electrolytes.

(4) Juice beverages: Revitalized through generational upgrades, achieving a year-on-year growth of 15.6%. In December 2024, Nongfu Spring's 17.5-degree freshly squeezed orange juice entered Sam's Club and became a hot seller, topping the flavored juice list during the Spring Festival. This product relies on the company's largest comprehensive processing plant in Asia located in Xinfeng, Jiangxi, achieving orange juice extraction within 36 hours to ensure freshness.

(5) Other products: Soda water, carbonated beverages, flavored drinks, lemon juice beverages, coffee, plant protein beverages, and some fresh fruits and other agricultural products, with a year-on-year decline of 9.8%.

2.2 Q&A

Q: In 2024, the company faced difficulties such as organized internet attacks, yet still delivered a high-quality report. What are the focus and growth expectations for the water business in 2025?

In terms of the beverage business, it previously focused on water and tea, with a slowdown in tea beverage growth in the second half of the year. What are the strategies for the beverage business and the growth outlook for tea beverages in 2025?

A: In 2024, public sentiment had a significant impact on the company, with packaged water products declining by 21.3%, but overall performance remained stable. The packaged water market began to steadily recover in the second half of the year, maintaining the industry's top position for the year. Tea beverages achieved a year-on-year growth of 32.3%, with increased distribution and market share. The growth rate in the second half of the year was lower than in the first half, mainly due to the high base effect from the second half of 2023. For 2025, in terms of the water business, the company has formed a full-category and full-spec product matrix and is confident in recovery, but whether it can fully return to pre-pandemic levels needs to be observed during the peak season.

In terms of the beverage business, the sugar-free tea market has significant growth potential and may surpass water to become the main track in the future. The company will continue to deepen its multi-brand and multi-category layout, promoting growth through R&D, channel distribution, and marketing activities. Additionally, the company insists on building and laying out water sources to strengthen consumer awareness of high-quality water.

Q: What are the growth expectations for the juice business in the next three years and how to enhance product strength and profitability through upstream supply chain utilization? What are the reasons for the recovery and improvement of profit margins for tea beverages and juices in the second half of 2024, and what are the revenue, cost, and profit outlook for 2025?

A: From a consumption perspective, per capita fruit consumption in China is relatively low compared to developed countries. In the past, juice consumption scenarios were mainly for meals, but with the increase in per capita income and consumption power, juice consumption scenarios are diversifying, such as for breakfast vitamin supplementation. From a product perspective, consumers' pursuit of quality is gradually increasing, shifting from mixed juice to a focus on 100% juice and not-from-concentrate (NFC) juiceFarmers in areas such as Gan Nan and Xinjiang have been deeply cultivating orchards for a long time. To achieve high-quality standards for juice, there are extremely high requirements for the entire supply chain from planting to cold chain transportation, and farmers have been working hard in this area for many years. When the consumption power of the juice market increases, farmers are well-prepared in product research and development and industrial capacity building, which is expected to bring a new growth curve and instill confidence in the long-term development and stable growth of juice.

As the scale of tea beverages increases, the overall net profit margin is also improving, with a slight increase expected in 2024.

The profit margin for juice is relatively low compared to other categories, and the juice products from Gan Nan navel oranges are currently in a strategic loss-making phase:

First, because the real fresh-squeezed period for orange juice is only 45 days in the autumn, with significant upfront investment but a short operating time, resulting in low asset utilization;

Second, the overall consumption of the juice industry has not fully recovered, and the scale is relatively small.

In the future, as overall consumption and competitiveness improve, the juice scale will expand and will be able to achieve substantial profitability, which requires long-term cultivation and construction.

Q: Will the water business strategy in 2025 focus on developing red bottled water, and is purified water just a test? How will the company respond to intensified competition in the beverage industry? What is the strategy for expense investment? What impact does ready-to-drink tea have on packaged tea, and what is the company's view?

A: The company has always emphasized promoting both red and green bottled water together, strengthening the quality differentiation between the two. Natural water, healthy water, and mineral-rich water are characteristics of the farmer's water category, and the source of water and natural water are the biggest differentiators from agricultural products, and this commitment will not be relaxed.

Purified water is not just a test, as there is consumer demand for it; it has a better taste, is crisper, and does not carry a mineral taste or texture, making it suitable for quenching thirst. Although purified water is not suitable for long-term consumption by the human body, if there is consumer demand, the company will display and distribute it, allowing consumers to choose freely. Currently, the 550ml specification of purified water will not expand to other specifications shortly, and the company's strategy of promoting the differentiation of natural healthy water will not change.

Competition in water, beverages, and tea beverages is intensifying from 2023 to 2024. According to the product coding numbers from the China Goods Coding Center, beverage codes increased by more than ten points last year, indicating that many new products have been launched. The company will not anchor to a specific profit margin but will dynamically adjust resource allocation based on competitive conditions.

The overall net profit margin is expected to reach 28.3% in 2023-2024, and the company believes this level is high. The high profit margin provides the company with ample space to increase investment, and winning the competition and continuously enhancing competitiveness is the direction pursued in 2025 and the following years.

Ready-to-drink tea and packaged tea will compete with each other, as there is a relationship of mutual rise and fall in consumer drinking scenarios and demands. However, in the long run, the love for tea drinking and various blended tea flavors will help elevate the overall tea beverage market.

Some consumers of Nongfu Spring use its tea products to make their fresh tea, indicating an interaction between the two. Moreover, all beverages from Nongfu Spring use high-quality natural and healthy raw materials, and bottled beverages have a freshness advantage over ready-to-drink tea in terms of taste. As consumer demands for fresh raw material quality increase, the company's competitive advantage will be further reflected. Q: What are the competitive strategies and growth conditions of Chapai? What is the growth rate and market share change in the sugar-free tea industry, and what is the forecast for 2025? What are the trends in tea volume and acquisition perspectives in the second half of 2024? What are the trends in raw materials and cost control for 2025?

A: This year, the company aims for double-digit growth across the entire beverage market and is confident in gradually achieving this. Over the past three months, the tea business has gradually improved, but whether it can fully recover to pre-pandemic levels will depend on the performance during the peak season. Within the entire beverage market, the growth rate of the tea category will still be higher than that of functional drinks and juice beverages, but since the scale has reached a certain level, a growth rate below 30% is also possible; however, there is still overall incremental space.

The company does not disclose growth figures by brand, but in 2023 and 2024, the overall growth of the tea business and Chapai is in line with expected targets. The growth of the sugar-free tea category is higher than that of Chapai, and within the tea category, the proportion of sugar-free tea is also higher than that of Chapai. The company will focus resources on channels, occasions, time points, and consumption scenarios that can significantly enhance competitiveness, making dynamic adjustments and layouts to continuously improve the penetration rate and consumption of Chapai.

Compared to 2023, the proportion of sugar-free tea in the overall tea beverage market has steadily and rapidly increased over the past three years. Three years ago, the proportion of sugar-free tea in the overall tea beverage market was only about 5% or even lower, and by 2024, different data shows it has reached over 20%, with some industry research reports indicating it could be as high as 25% or even more.

The overall industry growth rate has gradually slowed from previous high growth rates, which is a normal trend, and the company's sugar-free tea products show the same trend.

In recent years, the increase in sugar-free tea has come from both improved penetration rates and increased per capita consumption. In 2024, Dongfang Shuye and Chapai will both see improvements in penetration rates and per capita consumption, and this trend will continue into 2025, but it is difficult to provide an accurate forecast for 2025. Whether the growth rate of tea can maintain double-digit growth in the coming years will depend on industry dynamics.

From an industry perspective, there are price promotions that exchange prices for volume during certain channels, such as during e-commerce promotions or major client events in modern channels. For Dongfang Shuye, the company's overall investment is based on a stable pricing and promotion mechanism, without increasing larger price discounts. The company hopes to deepen its long-term market position and competitiveness, not relying on price wars for short-term profits. The profit margin of the tea category is expected to remain stable and increase in 2024.

Inventory growth is mainly due to the stocking of agricultural products (tea and juice). Juice is stocked seasonally, as the growth of 17.5 and NFC juice is high, necessitating increased inventory to ensure product supply in 2025. In terms of tea, the tea business scale has reached 16.7 billion, and the company uses fresh original-leaf tea, which has high requirements for quality and supply assurance.

In 2024, the company will launch its factory project, from raw tea to refined tea to blending, reducing pure procurement from third-party suppliers and transferring inventory controlled by suppliers to the company's balance sheet. Although this will increase raw material inventory, it is important for long-term supply and quality assurance. It is expected that PET prices will be lower in 2025 than in 2024, and the company will continue its targeted procurement strategy as in previous years.

Q: What is the revenue situation and inventory status for the first two months of 2025? What is the capacity ramp-up and utilization rate of the newly built water plants in 2024? What is the impact on gross margin?

A: Currently, it is inconvenient to disclose specific data, but the overall revenue has recovered well in the past two months, in line with the expectations for achieving the annual target, and inventory remains at a healthy level. The company monitors inventory levels weekly and monthly to ensure that the enterprise, distributors, and retail outlets maintain normal inventory turnover levels, with healthy and positive turnover being the primary goal.

The capacity utilization rate in 2024 is expected to decrease, especially with a significant decline in the water category, leading to a reduction in water line capacity utilization. However, the direction of building water source factories and investing in leading equipment in universities and industries remains unchanged, as the construction cycle is long, and short-term setbacks do not affect long-term strategic decisions. Once an efficient industrial supply network is established, it will help achieve overall performance, and currently, Nongfu Spring's gross margin and net margin are at a high level.

Q: What is the distribution rate of water and tea beverages, and what is the Capex distribution for 2025? What are the reasons for the reduction in labor costs in 2024?

A: The distribution rates of water and tea beverages are close, with still room for improvement. The Capex for 2025 is expected to be at the same level as in 2024, and it will depend on the progress of overseas development plans. If suitable overseas projects arise, the Capex for 2025 may increase. In recent years, the distribution rate of tea products (Tea Pi and Dongfang Shuye) has approached that of water, and there is room for improvement in the distribution rates of both water and tea, with the potential for increased per capita tea consumption.

The Capex for 2025 will be similar to previous years, with the vast majority of investments in building factories at water source locations and equipment investments, including new factories and upgrades of old factory equipment (replacing low-speed lines with high-speed lines), as well as ongoing investments in freezers, refrigerators, and IT equipment.

Labor costs are influenced by year-end bonuses and housing incentive systems, which are linked to sales and performance achievements. From 2022 to 2024, labor costs in 2024 are expected to be lower than in 2023 but higher than in 2022, as over 28% of sales achievements in 2023 affected labor costs.

Q: What is the impact of large-packaged sugar-free tea on the average unit price and the trend for 2025? What are the changes in market share and volume for the water business at retail terminals in the second half of 2024?

A: In 2023-2024, a 900ml package was launched, and this year, a 1.5-liter family consumption and sharing package was introduced. The retail unit price per liter for large packages is lower than that for 500ml packages, which will lead to a decrease in the average unit price. The purpose of launching large packages is to expand consumption among more people and in various scenarios, which can drive more consumption and high-frequency consumption scenarios, benefiting overall market growth.

From the perspective of retail terminals, the market share of water continuously declined from March to May 2024, but began to improve month-on-month starting in June; however, the market share is still lower than in 2023, but the recovery momentum continues.

The decline in retail volume in the second half of the year is less than during the pandemic impact period, but due to different data sources for retail sales statistics within the industry, there are discrepancies in statistics, making it difficult to make absolute judgments about retail volume in the first and second halves of the year: Is the growth rate and profit margin guidance for the tea beverage business over 20%? What are the revenue growth plans for the next 3-5 years and the main contributing products? What is the expense ratio plan for 2025?

A: Regarding the growth rate of tea beverages, we cannot provide a guarantee that it will be over 20%. At the current scale, tea beverages can maintain or achieve long-term double-digit growth, but the specific level will depend on this year's actual performance and peak season performance.

As for profit margin guidance, from the perspective of gross margin, raw material costs vary. Machine costs may be slightly lower than last year, while agricultural raw materials may be slightly higher. The company's net profit margin of 28.3% is already at a relatively high level in the industry, and we will not anchor this profit margin. Instead, we will dynamically decide the investment scale based on competition, market conditions, and product promotion, so we will not provide profit margin guidance.

For growth in the next 3-5 years, it should be viewed dynamically. The company focuses on achieving performance in 2025, working on the recovery of the water market, and maintaining overall brand and channel health, and only on this basis can we discuss future strategic goals.

In terms of expense ratio planning, Nongfu Spring has always been a dynamic process, planning on a quarterly or even monthly rolling basis. The principle is to maximize input-output efficiency and to invest based on dynamic changes in the market, competition, and consumers. Currently, the AMP planning does not have significant fluctuations, but adjustments will be made dynamically before the peak season ends, so we cannot provide profit margin guidance.

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