During the Spring Festival, Ruixing ($ Ruixing Coffee (ADR).US) once again appeared on the screen. During the Chinese New Year period, you always see things like "900 orders in one day, two-hour wait in line" or "Ruixing makes a fortune in the county."

From "the fastest IPO in history" to "financial fraud and sky-high compensation," Ruixing's stock price has gone from high to low. The stock price has fallen from a high of $51 to less than $1, a drop of 98%. Two years in the blink of an eye, Ruixing, which entered the pink sheet market, seems to have regained a new life after restructuring, slowly crawling back to $28.

At the same time, China Petroleum, China Post, Tongrentang, Goubuli, Yuanfudao, Li Ning, Anta, and Huawei have all crossed over into the freshly brewed coffee market.

Even the former founding team of Ruixing, Lu Zhengyao and Qian Zhiya, have returned to the freshly brewed coffee track through the newly established Kudi Coffee and set a grand goal of 10,000 stores in three years. Is it easy to make money in the freshly brewed coffee market?

With curiosity, the Dolphin Analyst will explore with you the development and changes of China's freshly brewed coffee market and gain a deeper understanding of this company - Ruixing. In this first part of Ruixing, the Dolphin Analyst will first take a look at the situation of the freshly brewed coffee track:

1. What are the sources of China's freshly brewed coffee market growth potential?

2. In the face of new brands continuously entering the track and multiple squeezes from substitute new-style tea drinks, where is the ceiling for freshly brewed coffee brand stores?

The core conclusion of the Dolphin Analyst is as follows:

1. Due to its unique functionality (compared to tea drinks) and better flavor retention ability (compared to instant and ready-to-drink coffee), when Ruixing and other high-performance brands like Manner compete, it promotes the rapid growth of the industry. In the past five years, the compound growth rate of the freshly brewed coffee industry has exceeded 30%.

2. Against the background of the increasing per capita coffee consumption and the increasing penetration rate of freshly brewed products, the industry will maintain a faster growth rate in the future, with an expected compound growth rate of over 20%.

3. Although the current industry leader's market share is low, only 6%, considering the commercial model and the development process of similar industries and the concentration of leading companies, it is expected that the single-brand market share of the top companies in the freshly brewed coffee industry can continue to increase, but it is difficult to exceed 10%.

4. Benefiting from market sinking and store encryption, as the brand with the largest number of on-site coffee shops in China, in the next three to four years, Ruixing can see a potential number of stores of 14,000, with more than 60% of new store space remaining.

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1. Heat is difficult to dissipate, and expansion is accelerating

According to Ruixing's latest financial report, in the third quarter of last year, its revenue was CNY 3.9 billion, a year-on-year increase of 66%. This is the second consecutive quarter that Ruixing's revenue has exceeded CNY 3 billion in a single quarter. And the operating profit for the quarter also exceeded CNY 500 million. Since the end of 2021, Luckin Coffee has disclosed that the number of stores has exceeded 6,000, surpassing Starbucks for the first time in China. More than a year has passed, and Luckin currently has more than 8,000 stores. In January alone, the number of new stores was close to 500. And since the end of last month, Luckin has launched a new round of partner recruitment for 2023.

Compared with the previous round, the cities covered by this recruitment have further expanded (this round covers 15 provinces and 80 cities, while the previous round covered 9 provinces and 41 cities), and most of the new cities are sinking markets in southwestern and central China. During the Spring Festival period, the return home tide caused many county coffee shops to sell out, and Luckin's phenomenon of selling out in county towns also makes the company's franchise applications very popular.

Looking at the overall situation in China, the development of the coffee industry seems to have entered an accelerated period. According to data provided by Qichacha, there are currently 174,000 coffee-related enterprises in China. In 2021, 26,000 new ones were added, an increase of 16% year-on-year; in 2022, 36,000 new ones were added, an increase of 37% year-on-year. Even with the impact of the epidemic (the sporadic outbreaks in China in 2022 are more widespread than in 2021, and the total social retail sales in 2022 will decrease year-on-year), the registration of new enterprises is still accelerating.

Not only Luckin, other brands are also quickly seizing the sinking opportunities. Starbucks plans to increase its store count by 50% from 2022 to 2025 (about 3,000 stores), Tims China expects to have more than 2,700 stores by 2026, and the small-store model Kudikafei plans to open 2,500 stores this year and expand to 10,000 stores by 2025. In addition to opening stores, there have also been numerous financing events in the coffee industry from 2021 to 2022.

So, how big is China's freshly ground coffee market, which is so attractive to capital?

II. "True Story" or "False Logic"

As one of the world's three major non-alcoholic beverages, tea and coffee have always been popular. Especially in China, non-alcoholic beverages (also known as soft drinks) have maintained a relatively good growth rate for the past decade. However, after a long period of consumption structure upgrading, the industry growth rate of non-alcoholic beverages has slowed down. The current compound growth rate is about 6%, and the overall scale of the industry is close to one trillion yuan. **

After carbonated drinks, bottled drinking water, bottled tea, juice and functional beverages became the mainstream categories in different stages of China's beverage industry, the change in mainstream beverage categories began to accelerate in 2010, and the concept of freshly made drinks based on "freshly made, leisure, and ready-to-drink" was formed, which was accepted and highly recognized by consumers.

Freshly made drinks such as freshly made tea drinks (using tea or tea soup as raw materials, adding dairy products, fruits, grains and other food ingredients and additives) and freshly ground coffee (using fresh roasted high-quality coffee beans, made by shop assistants or baristas on site in the shop) based on store-made were becoming one of the fastest-growing sub-categories in the industry.

Currently, the market size of freshly made tea drinks is about twice that of freshly ground coffee. After rapid growth in 2018, the industry's growth rate has gradually fallen to more than 10% in recent years, while freshly ground coffee still maintains a high growth trend, with a compound growth rate of more than 20%, and the current market size falls between CNY 80-100 billion.

Dolphin Analyst will analyze the possible future development paths of the freshly ground coffee market from three aspects: 1. Cultivation of coffee drinking habits; 2. Mutual substitution between tea drinks and coffee in the ready-to-drink market; 3. Mutual substitution among different forms of coffee in the coffee market.

2.1 How to cultivate the habit of drinking coffee?

According to Deloitte's consumer survey, regardless of age or geographical location, the main reason why the vast majority of consumers drink coffee is for physiological refreshing and brain-stimulating purposes, that is, what consumers actually need is caffeine.

Moderate caffeine intake can effectively relieve fatigue, stimulate nerves, and is more widely used in beverages, and has a certain addictive effect. Compared with other soft drinks, freshly ground coffee has a higher caffeine content, stronger refreshing function, and more addictive effect.

As for the characteristics of coffee consumers, the higher the income, the higher the penetration rate of coffee, and the higher the frequency of intake. Moreover, as the drinking years increase, the dependence and addiction to coffee become stronger.

Actually, what is implied inside is that income stratification often represents different work pressure or social pressure. The higher the income, the greater the pressure, and the more need for caffeine to relieve it.

Therefore, although the overall per capita coffee consumption level is extremely low in China, observing only first and second-tier cities, the consumption frequency of consumers who have already formed coffee intake habits is not lower than that overseas, almost at the level of one cup per day. This means that the main reason for the low overall coffee consumption in China is the low penetration rate, rather than the low frequency of consumption.

Over the past decade, the compound growth rate of per capita disposable income and per capita food consumption of residents nationwide has been 8% and 7% respectively. The increase in disposable income has become the basic driving force for the development of the beverage industry, but the pressure that comes with economic development is also increasing day by day.

According to the "2021 Exercise and Sleep White Paper" released by the China Sleep Research Association, there are currently more than 300 million people in China with sleep disorders, and 80% of them are young people. The causes of insomnia are many: excessive stress, disordered life rhythm, anxiety, depression, and so on. Half awake and half drunk, early C and late A, coffee during the day and alcohol at night have become the life-saving tools that contemporary working people are keen on.

This has also become an inevitable social reality. The pressure of life and work makes consumers easily succumb and develop a habit of using caffeine to start a chaotic day. However, caffeine can not only be extracted from coffee beans, but traditional tea also contains this alkaloid, and Chinese tea culture has developed for thousands of years. Can freshly ground coffee and freshly made tea drinks replace each other?

Dolphin Analyst believes it's difficult.

From the composition point of view, coffee and tea seem to have some substitutability. Older consumers do rely more on tea for refreshment than coffee. But the drinking habits of coffee and tea are ultimately different.

Firstly, the industrial chain and process of coffee are mature and stable, and there will be a relatively uniform standard for the content of caffeine. The choice of variety and flavor is relatively clear compared to tea.

Secondly, the variety, origin, climate, and processing conditions of tea and coffee beans will all affect the caffeine content. The caffeine content in coffee beans is generally about 1%-2%, and in tea leaves, it is about 3%-4%.

Although the caffeine content of coffee beans is even lower than that of tea leaves, due to the brewing habits, most coffee is brewed once, and according to the industry's production ratio, the amount of coffee beans used is higher, while the amount of tea leaves is generally less or will be brewed multiple times. This also makes consumers rely more on coffee for their refreshing needs. This also allows coffee to avoid the substitution risk of other beverages, which is conducive to maintaining its market size growth rate. 2.3 Freshly Grind vs. Instant

Some investors may be curious, although coffee has no substitute like other beverages, coffee itself has multiple forms of consumption. From the perspective of the number of cups consumed, freshly ground coffee accounts for a very small proportion in China. Why has the Dolphin Analyst always focused on the freshly brewed market?

First, in terms of functionality, freshly ground coffee is directly extracted and consumed after grinding coffee beans into powder, without multiple high or low-temperature industrial processing, which better preserves the oil and aroma of the coffee itself, and also has a higher caffeine content, making it more refreshing.

Second, in terms of product experience, the ingredients of freshly ground coffee are also very simple, only coffee beans and water (some flavors add milk), most of which use Arabica beans. There is no artificial flavor of 3-in-1 coffee, and there is a big difference in taste compared to coffee powder.

In the past, providers of freshly ground coffee in China were mainly operated by big stores such as Upper Island Coffee and Starbucks, with unit prices ranging from 30-80 yuan/cup, selling social space more than products. The unit price of instant coffee is generally between 1-2 yuan, with a wide range of price gaps in the middle, giving instant coffee a good living space.

However, with the rise of small store models (such as Luckin Coffee), the price gap of 10-20 yuan/cup in the middle has been quickly filled. This model can quickly enter the market with high cost performance, eliminating the "space premium" of previous consumer freshly ground coffee. And by various preferential means, and by keeping the coffee flavor rich while making it a coffee drink (compared to the advantages of instant coffee), it can cultivate consumers' habits of coffee intake and quickly increase penetration rate.

Comparing with the development of the coffee industry in Japan, we can also find some patterns. Japan has also experienced the process from instant to bottled (instant) and then to freshly grind. Compared with this, China has a certain difference, skipping the stage of rapidly growing instant coffee.

Before 2015, instant coffee was popular in the domestic market for a short time. Stores like Luckin Coffee broke the traditional industry evolution process and directly jumped to economic freshly ground products (similar to Japan's convenience store coffee, but the taste of domestic convenience store coffee is generally poor).

According to research by Dolphin Analyst, the consumption of instant coffee in China is currently around 12 billion cups, with an individual consumption growth rate of 12%.

Assuming the compound annual growth rate of coffee consumption remains at 12% over the next five years, and the permeability of freshly ground coffee within the overall coffee market reaches 30%/40%/50%. Calculating based on an average price of RMB 25 per cup (RMB 15 for Luckin and RMB 35 for premium coffee), the freshly ground coffee market will reach RMB 190/250/300 billion respectively. Over the next five years, the industry's compound annual growth rate will be 16%/ 22%/ 28% respectively.

It is extremely optimistic to achieve a 50% permeability rate for freshly ground coffee within five years, but a 30% permeability rate is likely to be achieved given the current expansion rate of chain brands. That is to say, in the next five years, without considering changes in prices, the industry has doubled its space.

Therefore, given that the freshly ground coffee market has steadily increased overall coffee consumption, and that the per capita coffee consumption and freshly ground coffee permeability rates have both increased year by year, it is possible for freshly ground coffee to maintain a growth rate of over 20% in the past three years.

3. How much space is left for "enclosure"?

Considering that the growth rate of freshly ground coffee can continue for some time, as a leading company in the industry, how many stores can be opened before the market becomes saturated?

3.1 What kind of store is easier to break through?

In the past, the industry leader Starbucks was most fond of making comparative analysis. However, since the end of 2019, Luckin's number of stores has surpassed Starbucks, becoming the number one in the domestic industry. It seems that there is no other comparable object.

However, Dolphin believes that Luckin and Starbucks are completely different, with completely different models. The former's marketing point is similar to that of "convenience stores," while the latter's marketing point is the third space ("large store management"). Therefore, it is almost inevitable for Lucky Coffee, with its small store model, to surpass Starbucks in terms of store numbers in a shorter time.

"Small store model" usually refers to stores with an area of about 40-50 square meters (coffee counters in fast food restaurants, convenience stores, and street shops are about 5-10 square meters), which are generally without seating areas and only support online ordering, i.e., self-pickup or delivery. "Large store model" usually refers to stores with an area of about 100-150 square meters, supporting offline checkout, and having a certain number of seating areas for consumers to dine in.

Different modes determine completely different operation processes for freshly ground coffee brand, thus there are differences in corresponding store models and marketing strategies. The most direct reflection is the difference in store locations and target customer groups. While China can accommodate nearly 300,000 convenience stores (with a total of 250,000 domestic convenience stores expected by 2022), it can hardly accommodate 300,000 coffee shops of a similar level to Starbucks. This has created loopholes for emerging coffee brands in recent years.

Compared to traditional brands such as Starbucks, emerging freshly ground coffee brands, such as Luckin and Manner, specialize in various dimensions such as coffee taste, flavor characteristics, high cost-effectiveness, store style, and space experience, achieving differentiated positioning from large traditional chain brands.

This type of store is generally below 20 square meters (similar to convenience stores), and with a few high cost-effective star products (with an actual average payment price not exceeding 20 yuan/cup), consumers can buy and leave, achieving the maximization of differentiation and efficiency.

This mode is the easiest to open and to scale among all types of coffee shops, and it is also the easiest to sink. Therefore, among the brands with more than a thousand stores in China, except for Starbucks, all other brands have a single price of less than 20 yuan.

Regarding the market share level of industry-leading companies, Dolphin Analyst believes that it can be considered from the following two aspects:

Due to the higher standardization of coffee than tea, and the peculiarity of coffee taste (not easy to taste good), it relies more on brand endorsement, thus the market share of the coffee industry's leading companies in the past was usually higher than that of the tea industry. Luckin's speed is to open eight thousand stores in six years, and the store market share is about 6-7%, while the market share of the tea drink leading company, Meet Fresh Ice City, is less than 6%.
Compared with the convenience store industry, thanks to the large number of gas stations in China (about 120,000), the market concentration of convenience stores is higher. The market share of the top three convenient stores in China - Yiji, Meiyijia, and Kunlun Haikeshi - is 11%, 10%, and 8%, respectively, and both Yiji and Kunlun Haikeshi have gas station backgrounds. A more normal reference is the 10% market share of Meiyijia.

Combining the above two points, as the industry leader of freshly ground coffee, Luckin's future store market share will probably fall between 8-10%.

3.2 What is the Store Ceiling

By 2022, the number of freshly brewed tea shops in China will be close to 500,000, while the number of freshly ground coffee shops will be close to 120,000, with a difference of three times in terms of quantity.

If the number of stores in the future no longer grows, but the competition structure affects the concentration of the market share of leading companies (similar to the logic of the competition of stock hotels in 2018), assuming that the market share of the leading companies (Luckin) increases from the current 6% to 10%, i.e., 12,000 stores, there is still 40% of space for Luckin, which is the most conservative estimate. However, the industry has not yet entered the stage of competing with the existing stock. **

But according to the current industry growth trend, it is unlikely that the number of coffee shops will remain unchanged in the future.

There is a significant difference between the experience of coffee and tea. Coffee tastes sour and bitter due to the caffeine content, and coffee products that cost 8 yuan or less do not taste as good as tea. For example, convenience store coffee is not highly accepted in China, but the acceptance of tea drinks at stores such as HEYTEA is still reasonable.

There are also significant differences in consumption scenarios between the two. Coffee emphasizes its stimulus functionality, and its audience is smaller than the consumer group with pure sweet intake needs. Therefore, the number of coffee shops is unlikely to surpass that of tea shops, and may even be less than convenience stores (250,000 stores).

Dolphin Analyst believes that the process of tea drink brands' evolution can be considered. Considering that HEYTEA has developed for over 20 years and has over 20,000 stores (similar to convenience store leader) at present, it can be temporarily regarded as the industry's highest store ceiling.

In fourth- and fifth-tier cities: HEYTEA has the highest coverage rate, and because the customer unit price of Luckin Coffee is twice that of HEYTEA, we can roughly estimate that Luckin's density will not be as high as HEYTEA in low-tier cities. If the estimated quantity can only reach 50% of HEYTEA's, there will be about 4,000 stores.
In medium-sized cities: The customer unit price is relatively close to Tea Bay and ancient tea, but since there aren't many competitive brands, assuming that the store opening density can reach 1.5 times that of a single product brand, there will be about 4,000 stores.
In high-tier cities: Assuming the first-tier cities have already reached full capacity, new first-tier cities can be increased to the level of HEYTEA, which totals to more than 6,000 stores, thus the total number of stores nationwide can be 14,000, which is 65% more than the current 8,500 stores.

Summary:

Relying on the industry's still-fast growth, Luckin Coffee, which has fallen from its pedestal, has the opportunity to make a comeback, but of course, this cannot be achieved without its own optimization and reforms. This article is the first part of the deep report on Luckin Coffee, mainly based on the current development status of the freshly ground coffee industry in the context of the overall environment.

In the second part, Dolphin Analyst will continue to discuss Luckin's prospects forecast, and combine the industry structure and company's core competitiveness to analyze the company's future growth trends and make an estimation judgement of Luckin Coffee. Stay tuned.

Risk Disclosure and Disclaimer for this Article: Dolphin's Research and Analysis Disclaimer

Luckin Coffee (Part 1): Can the Coffee Craze Sustain in Small Counties?