Strengthening Brand Value (Nongfu Spring 2022H2 Telephone Conference)

Nongfu Spring ($ Nongfu Spring.HK) released its full-year performance report for 2022 after the market on March 28, Beijing time. For detailed financial information, please refer to Changqiao Dolphin's commentary " [Nongfu Spring: Grasp Tea Drinks, Return to Water Mao] (https://longportapp.cn/zh-CN/topics/ 4517013) ".

I. Management statement

1. Brief summary of financial performance in 2022

(1) Income: Although the sales revenue in 2H22 did not achieve double-digit growth, with the joint efforts of all Nongfu people, the full-year revenue increased by 11.9% to 33.239 billion yuan.

(2) Gross profit margin: The gross profit margin of 2022 was 57.4%, a decrease of 2 percentage points compared to last year, but the decrease in gross profit margin was offset by the increase in other income and the savings in sales & distribution expenses.

(3) Net profit: The full-year net profit reached 8.495 billion yuan, a year-on-year increase of 18.6%. The full-year net profit margin was 25.6%, an increase of 1.5 percentage points from 21 years. The increase in other income and gains mainly came from the exchange rate income generated by the IPO raised funds and the increase in bank deposit income.

2. 2022 performance

(1) By category

1) Sales revenue

- Packaged drinking water: In 2022, the operating channels were somewhat impacted, so new capacity specifications such as 4.5 liters and 6 liters were launched to further improve the product matrix of medium and large family packaging. Percentage year-on-year to 7.1%.

- Tea beverage products: Further gained recognition from consumers, with a year-on-year growth of 50.8%.

- Functional beverages and fruit juice beverages: Increased by 3.9% and 10.1%, respectively.

2) Gross profit margin

Under the epidemic situation, the strategy of focusing on resource management efficiency was adopted. Sales of other products decreased, and the increase in PET procurement costs led to a year-on-year decrease in gross profit margin of 2.1% to 57.4%.

(2) By brand

1) Changbai Snow

2022 is the Year of the Tiger in the Chinese zodiac, and it is also the eighth year of the release of the zodiac commemorative glass-bottled mineral water for improvement. In Chinese culture, the tiger symbolizes bravery, ferocity, and evil spirits, so it is a zodiac that Chinese people prefer. For Nongfu Spring, the tiger is a unique creature in the water source area of ​​Changbaishan, so the company has further extended the image of tigers to Changbai Snow and launched the Changbai Snow series packaging for the Year of the Tiger. At the same time, a documentary-style film "Unexpected Surprises for Every Snow" was shot for Changbai Snow, presenting the beautiful scenery after the snow in Changbaishan, as well as the daily life of various animals in Changbaishan during the snow season. Every drop of Changbai Snow originates from a snowflake on Changbaishan. Snow is the source of Changbaishan water and the source of all life. The company believes that continuous brand investment will continuously strengthen the brand value of "what kind of water source breeds what kind of life".2) ChamPi

In 2022, two new flavors were launched: Kumquat Pu'er Lemon Tea and Blueberry Oolong Tea. In addition, two 900ml drinking packages were also launched: Grapefruit Jasmine Tea and Yuzu Green Tea. The introduction of these products enriched the product matrix and expanded consumption scenarios.

1. Dong Fang Shu Ye

Two seasonal limited edition products were launched in 2022: Longjing New Tea was launched in the spring, combined with the theme of "Starting from a Cup of New Tea in the Spring" to promote and disseminate Chinese tea culture; During the Mid-Autumn Festival, the second season of Autumn/Winter limited edition product, Osmanthus Oolong, was launched with the theme of "Warming hands and heart", conveying the enjoyment of drinking late tea to consumers, and through multi-scene exploration, letting more people fall in love with Chinese tea.

1. Farmer's Orchard

In the second half of 2022, Farmer's Orchard underwent a comprehensive upgrade - adopting a new logo, new packaging, and five new flavors: Orange, Peach, Pineapple, Grape, and Hawthorn. Farmer's Orchard continued the product characteristics of mixed fruit juice and 30% juice content for 19 years, providing consumers with higher quality juice beverages.

(3) Water Source

In 2022, another thing worth noting is the use of Daming Mountain's water source and factory. Daming Mountain is located in Guangxi Province. It is a national-level natural protected area with a forest coverage rate of about 98.9%. The company's water source comes from Daming Mountain's mountain spring water.

So far, the company has strategically deployed 12 high-quality water sources throughout the country, from east to west, south to north.

1. Other Key Financial Indicators

• Cash and bank deposits: continued to increase by 3.4 billion, reaching 19.3 billion yuan.

Interest-bearing loans: similar to last year, at 2.4 billion yuan.

• Net amount of current assets: decreased to 3.76 billion yuan, mainly due to the increase in accounts payable generated by factory and equipment investment, and the increase in seasonal costs and sales discounts.

• Capital liability ratio: decreased to 10.5%, mainly due to the increase in equity.

• Foreign exchange revenue: Due to last year's foreign exchange fluctuations, the IPO raised 370 million yuan in foreign exchange revenue.

• Inventory turnover days: further reduced from 54.8 days to 50.7 days.

• Accounts receivable turnover days: basically unchanged from last year.

• Basic earnings per share: further increased to 0.76 yuan, and we will distribute a dividend of 0.68 yuan per share this year.

1. Conclusion

The 2022 performance shows that the company's business has strong resilience, and the team is diligent and able to quickly respond to environmental changes. In 2023, the company will invest in brand to make up for the insufficient investment in the past three years; it will also invest further in team building. In the past three years, we have realized more deeply than ever before that only when every person in the team can take responsibility, have independent thinking and problem-solving ability can we maintain long-term and healthy operations. In 2023, we have full confidence in our business.Section 2: Q&A

Q: How do you view the growth trends of product categories, especially functional drinks and the future of tea?

A: First of all, after the pandemic is lifted, people's mobility has greatly increased, which is a great opportunity for fast-moving consumer goods, especially direct drinking products. Although funding and logistics may seem tight, there is still consumption power for drinking bottled water and tea.

Secondly, although the Chinese population increases slowly or even declines, the beverage population continues to grow - if you have the habit of drinking bottled drinks when you were young, you will still have this habit when you are 50 or 60 years old - therefore, in mature markets such as Japan, it is very normal for the elderly to drink bottled drinks.

(1) Tea: is a favorite drink of the Chinese, and with the trend of pursuing health, the future market space is very large.

(2) Functional drinks: Functional drinks are relatively special and more subdivided categories. Products in each subdivided industry such as energy-based vitamins, sports drinks, etc. cannot replace each other, and they all have their own dominant brands, such as company's JDB and Vitamin Water occupy a place in sports drinks and vitamin drinks. The sports scene has increased after the epidemic, and this category will also increase accordingly. However, if functional drinks enter into competition with other subdivided categories, more solid product reserves are needed, especially for products that are particularly strong in function and have an immediate sense of feeling, which requires time for reserves. Therefore, the company will increase its research and development investment in this area and launch new products at the appropriate time.

(3) Juice: All product lines are being upgraded.

- Orchard: The upgrade of orchards was carried out this year. Orchards were products for relatively offline markets. After this upgrade, both the packaging, taste, and products are more successful. At least for now, in second- and third-tier cities, it is very acceptable for consumers. This is a brand in 2019, and this important upgrade ensures future development.

- NFC juice: The promotion of NFC juice in first-tier cities is due to the increase in everyone's health awareness and the increasingly perfect cold chain channels. Therefore, this is another type of upgrade-from the original 30% or even 10% juice drinks to NFC non-concentrated and non-reconstituted juice, which is increasingly similar to the juice consumption habits of mature markets such as the United States, Europe, and Japan, and still has great potential in the future.

- Vitamin C: After the epidemic, the vitamin C small category has emerged. Lemon, lemon juice drinks, carbonated, non-carbonated, etc., all have new trends. The company has reserves for this type of product, such as the water-soluble vitamin C, which can satisfy the daily vitamin C needs in one bottle, and will strengthen this category in the future.

In terms of juice, it will upgrade through the marketing of old juice, such as increasing penetration in the NFC juice channel, and then launching new products to improve the juice category.

(4) Summary: Among the three major categories of tea, functional beverages, and juice, the company will invest the most resources in tea drinks, and significant progress has been made so far, and it is believed that the tea market has a large scale. Farmer has not yet reached the first share in these three areas, and the future potential is unlimited. As for other product categories, we will continue to pay attention to market changes.Q: Expectations for this year's gross profit margin given the downward trend in PET particle raw material prices?

A: Our procurement strategy for 2021 accurately predicted the increase in PET prices in 2022. As a result, in 1H22, our purchase price for PET has an advantage compared to our peers. However, this advantage disappears in 2H22, as most PET is purchased along with others.

This year, we do not actually have more price advantages regarding PET in the market than anyone else does. From the standpoint of PET, our gross profit margin levels will not have an advantage this year, and even the price of crude oil may increase. We will continue to monitor its trend. Currently, it is difficult to achieve better performance than the industry's.

Overall, our gross profit margin may not necessarily improve further from the base of 2022, but we can at least maintain the gross profit level of 2022.

When the raw material market is unfavorable to the company, it only needs to perform better than others; when the raw material market is favorable, it just needs to not perform particularly poorly.

Q: How much of this year's capital expenditures are related to investments in refrigerators in channels; and what is the overall brand investment plan?

A: The market investment this year focuses more on brand items. In the past three years, we did not have the opportunity and occasion to invest in brand items, and we have tightened the overall investment in brand items. This year, under an expanded backdrop, the budget for brand item investment is quite sufficient.

The official account has already launched a series of introduction articles about the source of water, including Changbai Mountain, Emei Mountain, and Taibai Mountain. We hope that consumers can see why our company's water source is good and learn about the ecological environment of the company's water source through this approach. Then, we will further invite consumers to the factory to see and personally experience where the company is good.

In terms of channels, although investment and planning have been done in refrigerators three years ago, there are some updates this year, but we will focus more on the utilization rate and output of invested freezers and the ability of the team to operate freezers.

Therefore, there are no excessively unexpected freezer investments in this part of the investment. The reason is that the freezer is a very difficult asset to manage. In the past three years, many stores are not in the original location, and there are new stores. All freezers need to be updated, replaced, inspected, etc. After evaluation, it is still necessary to focus on improving asset utilization rate, rather than excessively investing in such assets when the team's ability has not reached.

The refrigerator is a heavy asset, and regular investment will be made this year without additional special investment.

In addition, investing in multiple-door refrigerators is a preemptive strategy of our company. We set up investment in multiple-door refrigerators three years ago. Now many peers have realized this problem and have great icebox investments. Therefore, the management and investment in refrigerators this year face enormous competitive pressure, unlike the previous few years, when only farmers invested and were relatively easy to expand.

Q: Considerations for the pricing of various categories this year, including considerations for pricing after the launch of new products?

A: Promote overall sales work in a stable price system. We have always hoped to do healthy business that can ensure a certain level of profitability. This is not only the profitability that the company can ensure, but also the profitability that the entire distribution channel can ensure -- only if the entire team of cooperative partners can operate healthily, can the business be healthy and sustainable.Recently, many media reported that Hangzhou Datongshui has raised prices and predicted whether prices will rise this year. To be frank, each market has its own situation. If we focus on the prices of one city and SKU, and then promote it globally, it would be careless. There are price adjustments on individual cities and product qualities every year, which is a very normal business activity.

From this year's budget, there is no consideration for large-scale or directional price increases. Because the market has just recovered and started, and the sales willingness is also in the stage of recovery, there is not a very sufficient reason for raising prices. Hopefully, we can provide better services for distributors and consumers.

Q: Is there a possibility of increasing brand building and sales expenses ratio or overall period expense ratio and gross profit margin guidance for 2023?

A: We hope to achieve the double-digit growth target of income, but it is not a particularly high expectation. This expectation is set because we expect the beverage industry competition to be more intense this year, in this situation, it is more meaningful to have reasonable profits for the entire channel than to make a lot of sales. From the perspective of the entire recovery, the first thing is to turn the business back to normal, that is, to improve team capabilities, update sales tools, and restore brand building to normal. Sales and distribution expenses will definitely be higher due to increasing brand investment, but because the income growth of the past two years is considerable, the sales and distribution expenses ratio will not have a particularly big deviation compared to normal years. There is no need for advertising investment to be compensated synchronously with the cumulative growth of many years, so profits can be guaranteed to a certain level.

But there is no very high expectation for gross profit this year. Adding sales and distribution expenses to restore normal levels, there may be a year-on-year decline in net profit margin levels compared to last year.

Q: The impact of Kangshifu and Uni-President Juice on the orchard; the outlook for juice as restaurants and family gatherings recover this year; whether NFC juice is a long-term cultivation or will have a steep curve; whether there will be new products for bubble tea and soda water?

A: (1) Orchard

The growth in the second half of the year for orchards comes from the success of product upgrades and replacements. We did not pay special attention to the impact of competitors, and will not benefit from the catering market in the second half of the year. In the future, we hope that orchard sales will tend to be more normal, rather than particularly skewed towards one product in one festival.

(2) NFC Juice

The current volume of NFC juice is not particularly large, but it is definitely a future product trend, even a ceiling-level product in the juice category, with great market potential, and has been growing continuously for many years. It needs to strengthen consumer awareness of NFC juice products.

(3) Fresh Fruits

Last year, Apple's fresh fruit season was completely unable to operate due to the impact of epidemic prevention and control measures, which was a real loss. But at least for now, it seems that similar measures will not be taken this year, so we will not be affected.

(4) Other Categories

Creating new categories and achieving the top two market shares requires effort and time, and products need to be constantly tested and updated. We will continue to do this work. In addition, farmers have their own understanding of new products-they can be constantly improved and strengthened, and new small varieties or flavors can be introduced. We do not think that a product that has been on the market for more than three years is no longer a new product.Q: Will the dividend distribution increase in the future?

A: Currently, we are monitoring industry development opportunities and our operational capabilities still need improvement. Some of these capabilities may not necessarily come from internal growth, such as improving PET utilization, automation level, IT technology, and the feasibility of operating in cross-regional or overseas markets. Acquisitions, mergers, or strengthening capabilities through equity participation are options that we may consider.

Under these circumstances, it is difficult to promise a fixed dividend distribution ratio. We will seize suitable development opportunities and if there are particularly suitable opportunities, we will use cash to reward shareholders.

Q: After the pandemic is over this year, when will the growth target and pace be reassessed and adjusted, and which indicators will be mainly adjusted?

A: After setting the target for 2018, there were very few year-end adjustments made in the past three to five years. However, this does not mean that we will not seize market opportunities. Our team will strive to obtain sales opportunities but we will prioritize healthy management over revenue or profit targets.

There is performance pressure from sales representatives to management, but dealers also face sales pressure. Having performance pressure does not mean giving dealers an excessive inventory burden. We aim to maintain a healthy inventory turnover, emphasizing product distribution and sales.

This year we will focus on reorganizing and refining the basic work — the ultimate representation of management can be in numbers, but there must be healthy, long-lasting, and sustainable methods behind these numbers. Although we are relatively satisfied with the operating performance of 2021 and 2022, it is undeniable that we had to conduct online meetings in the past three years, and we were unable to provide performance coaching. This led to some deficiencies in our team. We will enhance team capacity building and personnel training this year and prioritize basic targets, basic execution, and personnel development. We will not ignore these core and basic capabilities and prioritize numbers.

Q: Will new tea drinks be launched? What are the main priorities and long-term plans for Changbaishan this year?

A: (1) Tea Drinks

Tea drinks, especially unsweetened tea drinks, are not only about marketing strategies, but also about technical management skills, such as tea raw material management, supply chain management, manufacturing processes, and filtration management. Filtration management is particularly important for semi-transparent packaged tea. Dongfang Tea Leaves has launched regular products such as Qinggan Pu'er and is now focusing on large-packaged tea. This is because after consumer habits have gradually formed, they feel that regular packaging is not enough. We do not rule out the possibility of launching new small categories. Seasonal limited editions are a regular move, such as Osmanthus Oolong in the spring, and Longjing now. This is mainly a marketing tactic and does not necessarily require much quantity.

Overall, unsweetened tea is a category that tests technical management capabilities, and it is not necessary to launch many new feverish products. There is still a lot of room for carbonated tea drinks in terms of channel penetration, and of course new products can be launched, but it is only about adding new flavors to replace the original unsatisfactory ones.

(2) Changbaishan

Nongfu Spring holds a good position in the Tri-element water category, mainly because Changbaishan has the best mineral water source in China. Additionally, it is a mineral water product category and the overall design is still good. We will continue to invest in these products to enable everyone to truly recognize their advantages.The advantage of Changbai Mountain actually requires time and resources to be tilted towards it in terms of advertising and content. It requires sustained efforts and confidence in the product in order to occupy consumers' minds, which is more difficult than occupying shelves.

Q: Investment volume in San Yuan water, expansion of San Yuan water source, and transportation cost in 2022

A: (1) Investment Volume

Generally speaking, it maintains growth without breaking it down, and there is a significant gap in the volume compared to Red Bottle Water, but it maintains a relatively stable growth trend. Overall, it is a strategic product, but it does not mean that it will have a higher volume than Red Bottle Water in the present, the gap between them may be the future space for this product.

(2) Water Source

Currently, the advantage of Changbai Mountain has not been fully tapped, and it still focuses on Changbai Mountain. In fact, every time a place is promoted, it requires huge costs, so currently resources are still concentrated in Changbai Mountain.

(3) Transportation Cost

First of all, farmers are porters with experience in managing transportation. Now there are 12 major water sources, and when there was only one Qiandao Lake, it was also transported to Xinjiang from Qiandao Lake - we should believe in the transportation efficiency and capacity of the porters.

In addition, the overall shipping cost of San Yuan Water is 10 yuan, and the price difference between San Yuan Water and Two Yuan Water is 50 yuan, so the shipping cost can still be borne. Now the water from Changbai Mountain comes with a railway line, and railways have their advantages in long-distance transportation, and in the future, other shipping methods can also be chosen.

Q: Cash Management Strategy

A: From a business perspective, only stable investments are made, mainly in the R0 and R1 deposit categories. Currently, even bonds will not be touched. More abilities are focused on operations, rather than financial management, and strive for insurance on the financial management end. But from another perspective, because the overall cash situation is good, there is a certain negotiating ability, which can persuade banks to offer better returns.

Q: Overseas Expansion Plan

A: Water is closely related to population density, and there is still a great opportunity in the Chinese market. Currently, all business focuses are still on the domestic market. It is tiresome to compete for markets that have already exceeded the average water consumption level instead of trying to increase it to the average level. They will also explore various overseas investments and market development opportunities, but at least not in the short term.

Q: The impact of many domestic retail stores (tens of thousands of online stores) on household consumption price trends and the company's views on this channel

A: Currently, there are probably more than 3 million stores that truly do business with farmers, so tens of thousands of stores will not have a big impact. Of course, they will pay attention to the prices of these online stores. Farmers still have stricter price policies in this regard and will not let tens of thousands of stores affect the pricing of millions of stores.

Q: Update on revenue guidance within three years to mid-teens

A: It will not be updated. From the standpoint of goals, the mid-teens is the range in which the company believes it can operate normally and healthily in the long term, so there will be no other changes in this regard.

The weather was still relatively hot in the second half of last year, which was relatively extreme in the past decade, whether such extreme weather will occur again this year depends on the weather. In the beverage industry, especially in the water business, in addition to their own efforts, it is also very important to rely on the weather.

Last year's climate was a big help to all beverage companies, with temperatures above 36 degrees and sales of water skyrocketing.

This year's hot weather in early March had little impact on the business, mainly the weather in the early part of June and the three months of 789.

Q: Long-term profit margin outlook; proportion of water in large and small packaging, and views on the sustainability of the growth rate of large packaging

A: (1) Profit margin level

There are many factors that affect it, and the biggest one is the level of PET prices that affect gross profit. With the current volume and scale, there are indeed adjustments to product mix and sales policies to smooth out the fluctuations. In addition, last year's significant exchange gain of 370 million is not sustainable. Therefore, the profit margin outlook for 2025 is slightly above 20%.

(2) Large packaging

The proportion of small packaging has declined to slightly over 60% from an initial proportion of 65% or 66% in recent years, and in the long term, it may be around 60%. This is similar to the international industry level. Although there are no companies in the world that do both large and small packaging, there are other brands that do large packaging, and looking at the specifications, there is still a slight proportion of bottled water for family use.