Nongfu Spring Co Ltd (HKG: 9633) is the leader of China’s packaged drinking water and beverage industry, occupying the top three position in the packaged drinking water, tea beverage, and functional beverage sector.

The company recently went public in a blockbuster initial public offering in Sept 2020. The IPO raised HK$ 8.35 billion of proceeds and was 1,147 times over-subscribed. It has made the company founder one of China’s wealthiest business magnate.

In this article, we shall delve into Nongfu Spring (Nongfu) business segments, its leadership position in China, its historical and latest financials to determine if it can continue dominating China’s huge bottled drinks industry.

Overview

Nongfu’s was founded in 1996 and has ranked first in China’s packaged drinking water market in terms of market share for eight years from 2012 to 2019. 

Since its foundation, Nongful has established itself as a health-conscious company that specialises in natural drinking water that comes from wells, mountain springs, lakes. This has been their unique selling point that targets Chinese consumers’ rising level of health-consciousness, as opposed to other players which sold natural mineral water and purified drinking water. 

Nongful controls ten quality water sources spread across China located in pristine areas with a clean environment. Some of these include renowned ecological spots such as deep underground water at Mount Tianshan in Xinjiang province, mountain springs in Mount Taibai (Shaanxi province), and Mount Emei (Sichuan province). 

Besides drinking water, Nongful has diversified into tea beverage, functional drinks, and fruit juice and attained top sales in this sub-sector. 

Nongfu’s product line-up and corresponding 2019 sales figure. Source: IPO Prospectus

Supporting Nongfu’s RMB24 billion sales in 2019 are its extensive distribution network that comprises more than 4,000 distributors and 10,00 sales person that cover 2.43 million retail sales points across China.

Packaged Drinking Water

Natural water is extracted from one of Nongfu’s water sources and treated with filtration and sterilisation process nearby production bases. The end product, packaged drinking water, contributed almost 60% of total revenue, or RMB14.3 billion of sales in 2019. 

Nongfu’s packaged drinking water comes in different volumes to cater to different drinking scenarios. These include small bottles for daily use, large volume for household consumption, sports bottle for active consumers, and glass bottled sparkling water as a high-end product for conference or banquet use. 

Source: IPO Prospectus

Packaged drinking water sales have grown strongly in recent years, with a compounded annual growth rate (CAGR) of 19.1% from the year 2017 to 2019. It also has the highest gross profit margin of 60.2% among its different products. 

Functional Beverage

Functional beverage is the second largest product segment which contributed 15.7% of total revenue in 2019 which amounted to RMB3.7 billion. This segment primarily consists of Scream and Victory Vitamin Water that targets sports enthusiasts. 

Source: IPO Prospectus

Functional beverage revenue grew at a CAGR of 13.5% from the year 2017 to 2019 and has a gross margin of 50.9% in 2019.

Tea Beverage

Tea beverage segment comprises Tea π and the sugar-free Oriental Leaf across popular tea types such as oolong tea, jasmine tea, and green tea. This is the third-largest revenue contributor with a 13.1% share of total revenue in 2019 or RMB3.1 billion of sales. 

Source: IPO Prospectus

This segment showed slower growth of CAGR 9.9% from the year 2017 to 2019 and a gross margin of 59.7%.

Historical Financials 

Nongfu registered strong growth in total revenue which increased from RMB17.5 billion in 2017 to RMB24 billion in 2019, equivalent to a CAGR of 17.2%. 

Gross profit is a key measure of operations efficiency as it takes into account raw material and packaging costs, manufacturing overheads, water treatment and transmission costs, and salaries. Nongfu had been able to maintain a high gross margin of above 50% in the past three years. 

Adjusted net profit that excludes one-off expense and non-cash items also showed steady growth and a healthy margin. 

Nongfu’s key financial figures. Source: IPO Prospectus and 2020 Interim Report

However, Nongfu is not spared from the impact of Covid-19 pandemic. Its revenue dipped 6.2% while gross profit stagnated in the first half of 2020 compared to 2019.

Strength and Opportunities

In the highly commoditised packaged drinking water market where little product differentiation is expected, Nongfu had established a strong brand using natural water as a unique selling point. Its classic marketing slogan of ‘Nongfu Spring tastes a little sweet’ (农夫山泉有点甜) and ‘We do not produce water. We are porters of nature’ (我们不生产水,我们只是大自然的搬运工)  are well recognised by Chinese consumers. Such strong marketing capabilities allowed Nongfu to enjoy brand premium and a high margin relative to competitors. For example, its 2019 net margin of around 20% is double the margin of 9.6% observed among China’s industry peers. 

According to Nognfu’s IPO prospectus, China’s soft beverage market is expected to grow at 5.9% a year to 2024 supported by increasing urbanisation, rising disposable income, and consumption upgrade. Specifically, the packaged drinking water and functional beverage would grow at 10.8% and 9.4% respectively, giving Nongfu a clear growth runway. 

The Negatives

The packaged drinking water and beverage industry in China is highly competitive. Major beverage companies such as Kang Shifu and Wahaha are diversifying their products and ramping up marketing efforts to capture a bigger share of domestic consumers’ wallets. This would further intensify competition, forcing Nongfu to invest in new products and marketing to protect its market share. 

Conclusion

Nongfu’s share price is trading at HK$42.65 as of writing, with a Price-Earnings ratio of 86 times. The share price has almost doubled from the IPO price of HK$21.50, netting the early investors’ substantial wealth. 

I opine that Nongfu is a major player in China’s high-growth yet strongly competitive beverage market. While its largest market share in packaged drinking water seems secure, it is facing strong rivals in the broader beverage sector. 

Coupled that with a sky-high valuation, Nongfu would need to show stellar earnings growth in the next few quarters to sustain its share price. Hence the company may be suitable for growth investors chasing substantial capital growth.  

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