Nongfu Spring is like Meituan

Nongfu Spring's predecessor was 'Xin'anjiang Yangshengtang Drinking Water' established in 1996 (renamed Zhejiang Qiandao Lake Yangshengtang Drinking Water Co., Ltd. in 1997), with a registered capital of 20 million yuan. In 2001, it was restructured and renamed 'Nongfu Spring Co., Ltd.' with a share capital of 147 million. Typically, restructuring into a joint-stock company is a preliminary step for an A-share listing, but it wasn't until 2003 that Nongfu Spring was designated as a 'prospective listed company' by the Zhejiang Securities Regulatory Bureau. It was not until May 2008 that Nongfu Spring signed an A-share listing tutoring agreement with CITIC Securities. At the end of 2018, through friendly consultation, the tutoring that had lasted for ten years was terminated. Nongfu Spring claimed it had 'no listing plans,' but CITIC Securities was not there to earn 'tutoring fees.' On April 29, 2020, Nongfu Spring submitted its first version of a listing application to the Hong Kong Stock Exchange. The sponsors were CICC and Morgan Stanley. It is suspicious that CITIC Securities accompanied the 'prince' studying for ten years without any reward. **-01-**Financial reports are so beautiful they don't look like a traditional enterprise 1. Sixty percent of revenue comes from selling water In 2017, 2018, and 2019, Nongfu Spring's revenue was 17.5 billion, 20.5 billion, and 24 billion yuan respectively, with a compound annual growth rate of 17.2%. Nongfu Spring's products can be divided into two categories: 'packaged drinking water' and 'beverages,' the latter including tea drinks, functional drinks, and juices. In 2019, revenue from packaged drinking water and beverages was 14.3 billion and 9.2 billion yuan respectively, with the former accounting for 59.7% of total revenue, up 1.8 percentage points from 2017. 2. Gross profit margin as high as 60% In 2017, 2018, and 2019, Nongfu Spring's total gross profit was 9.81 billion, 10.92 billion, and 13.31 billion yuan respectively. Packaged drinking water accounts for a large proportion of revenue and has a higher gross profit margin than other products; over 60% of Nongfu Spring's gross profit comes from this business. In 2019, packaged drinking water gross profit was 8.63 billion yuan, with a gross profit margin of 60.2%, accounting for 65% of total gross profit. Tea drinks and functional drinks have similar profitability, with 2019 gross profits of 1.87 billion and 1.92 billion yuan, and gross profit margins of 59.7% and 50.9% respectively. Together, these two businesses contributed 28% of total gross profit. In contrast, the juice business is the least profitable, with 2019 gross profit of 802 million yuan, a gross profit margin of 34.7%, accounting for 6% of total gross profit. 3. Good expense control In the chart below, the blue line represents gross profit (rate), and the colored stacked bars represent expenses (rate). Only when blue covers the colored bars is there profit. Nongfu Spring's charts are so beautiful they don't look like a traditional industry! In 2019, Nongfu Spring's gross profit was 13.3 billion yuan, with a gross profit margin of 55.4%; selling expenses and administrative expenses were 5.8 billion and 1.4 billion yuan respectively, with expense ratios of 24.2% and 5.8%. Except for a few industries like high-end liquor, traditional industries typically have gross profit margins not exceeding 30%. High-tech enterprises have high gross profit margins, but market expenses (customer acquisition costs) often approach or even exceed gross profit. Additionally, after implementing equity incentives, R&D and administrative expenses are high, and long-term, substantial losses are common. Nongfu Spring, a 'water seller,' has a gross profit margin not lower than high-tech enterprises, and controls expenses extremely well, which is worth studying. Some media say Nongfu Spring sells well because of good advertising, but in fact, advertising expenditure in 2019 was 1.2 billion yuan, accounting for 5% of revenue, which is not only not high for FMCG but very low. 4. Net profit and operating cash flow In 2017, Nongfu Spring's net profit was 3.4 billion yuan, with a net profit margin of 19%; in 2019, the net profit margin slightly fell to 18%, but net profit still increased to 3.6 billion yuan; in 2019, net profit and net profit margin both hit new highs, at 5 billion yuan and 21% respectively. Usually, when a company seeks to list, it tries to align the target market of its products with the preferred market for listing and financing. Nongfu Spring earns almost all its revenue from mainland China, making the A-share market the natural first choice, especially since mainland valuations are typically higher than those in Hong Kong and the United States. From the financial report data, Nongfu Spring is absolutely qualified for an A-share listing. But the company terminated its ten-year listing tutoring at the end of 2018, claiming it 'doesn't lack money.' A year later, it distributed 9.5 billion yuan in cash dividends, then went to Hong Kong to seek an IPO and raise 7 billion yuan (reportedly planning to raise US$1 billion). **-02-**Where is the bottleneck for scale expansion? 1. Is the water source sufficient? Nongfu Spring calls itself 'Nature's Porter.' Where does it carry from? From ten water source bases: deep lake water from Qiandao Lake in Zhejiang, Danjiangkou in Hubei, and Wanlv Lake in Guangdong; mountain spring water from Emei Mountain in Sichuan, Taibai Mountain in Shaanxi, Wuling Mountain in Guizhou, and Wuling Mountain in Hebei; mineral water from Daxing'anling in Heilongjiang and Changbai Mountain in Jilin; and deep groundwater from Manas in Tianshan, Xinjiang. According to Chinese law, taking water from natural sources requires approval from relevant agencies. There are two specific forms: one is that Nongfu Spring applies to the government and, after approval, obtains a water withdrawal permit in accordance with the law; the other is that a third-party state-owned water supply company applies for and obtains a water withdrawal permit and then withdraws water on behalf of Nongfu Spring. The chart below shows the approved annual withdrawal quotas for the ten water source bases. Among them, Qiandao Lake in Zhejiang can withdraw 21.66 million cubic meters of lake water annually, and the five sources in Changbai Mountain can extract 19.82 million cubic meters of mineral water annually. As of the end of 2019, Nongfu Spring's ten water source bases could collectively withdraw 86.49 million cubic meters of water per year. This year's total production of packaged drinking water was 13.38 million tons, only 15.2% of the approved withdrawal volume. Calculated at 400ml per bottle, Nongfu Spring's approved water withdrawal could fill 216.2 billion bottles, but in 2019 it filled 33.45 billion bottles (in reality, there are many bottle and barrel types). Based on the above information, it can be concluded: Water sources are not a bottleneck for Nongfu Spring's development, but they are also not a moat— Water sources are not a bottleneck because the current approved withdrawal volume is six times the actual withdrawal volume; Water sources are not a 'moat' for Nongfu Spring. For example, Qiandao Lake has a water surface of 573 square kilometers and a storage capacity of 17.84 billion cubic meters, and Nongfu Spring may not be able to monopolize it. Zhejiang is not the only province with lakes; if Nongfu Spring monopolizes Qiandao Lake, competitors can monopolize other lakes. 2. Are production lines running at full capacity? As of the end of 2019, Nongfu Spring operated 137 production lines nationwide, including 106 drinking water production lines and 31 beverage production lines. The median capacity utilization rate was about 50%. Nongfu Spring's production lines are 'built by water,' located around water sources. The earlier the water source base was put into operation, the higher the capacity and capacity utilization rate. The top five are Qiandao Lake, Changbai Mountain, Danjiangkou, Wanlv Lake, and Manas. The Qiandao Lake base, which started production in 1997, has an approved annual water withdrawal of 21.66 million cubic meters. As of the end of 2019, 26 packaged drinking water production lines had a total capacity of 6.83 million tons, with actual production of 4.17 million tons, a capacity utilization rate of 61%. In addition, Nongfu Spring also arranged 14 beverage production lines at Qiandao Lake, with a total capacity of 1.98 million tons and actual production of 1.2 million tons, a capacity utilization rate of 60%. Among the production bases built on the ten water sources, the highest capacity utilization rate is Wanlv Lake, which started production in 2005: 13 packaged drinking water production lines, with total capacity and actual production of 3.1 million tons and 2.02 million tons respectively, a capacity utilization rate of 65.2%. With abundant water sources and surplus bottling capacity, the bottleneck for Nongfu Spring's revenue can only be the market. Since there is little need to increase water sources or expand production capacity, there is also little need for listing and financing. **-03-**Nongfu Spring is like Meituan Nongfu Spring's bottled drinking water gross profit margin is as high as 60%, while Meituan's food delivery gross profit margin is less than 20%. They seem worlds apart, but don't be fooled by the difference in gross profit margins; these two companies are actually very similar. 1. Ex-factory price estimation In 2019, Nongfu Spring's bottled drinking water business revenue was 14.3 billion yuan, with production of 13.38 million tons, approximately 33.5 billion bottles (calculated at 400ml per bottle, same below), and an ex-factory price of 0.43 yuan per bottle. Financial reports show bottled water gross profit of 8.633 billion yuan, with a gross profit of 0.26 yuan per bottle and a cost of 0.17 yuan. In 2019, Nongfu Spring sold 754,000 tons of tea drinks, 1.08 million tons of functional drinks, 512,000 tons of juice drinks, and 78,000 tons of other products, totaling 2.43 million tons. Calculated at 400 grams net weight per bottle, total sales volume was 6.1 billion bottles, with an average ex-factory price of 1.6 yuan per bottle. Financial reports show beverage gross profit of 4.67 billion yuan, with a gross profit of 0.765 yuan per bottle and a cost of 0.835 yuan. Calculating based on the assumption of 400ml per bottle inevitably introduces errors. In reality, Nongfu Spring's drinking water is not all bottled; there are also 4L and 19L barrels; bottled water is not all PET bottles; there are also glass bottles; PET bottles come in 380ml, 400ml, 535ml, 1500ml, and other sizes; tea drinks and functional drinks also have various bottle types. The assumption of total annual output of 39.6 billion bottles is intended to use this number as a denominator to turn those 'astronomical figures' into a few cents or fractions of a cent that ordinary people can easily understand and perceive. Changing the denominator to 30 billion or 50 billion bottles would not fundamentally affect the conclusions of this article. 2. Cost and expenses of bottled drinking water The cost of bottled drinking water includes three main parts: PET bottles, packaging materials (cartons, etc.), and manufacturing expenses (including labor). Drinks like juices also add content costs. Using 39.6 billion bottles as the denominator, allocate 0.147 yuan in selling expenses (including 0.064 yuan in logistics) and 0.035 yuan in administrative expenses per bottle of drinking water. In 2019, the operating profit per bottle of drinking water was only 8 cents. As for beverages (tea drinks, functional drinks, juices), after deducting selling and administrative expenses, the operating profit is 0.58 yuan. Despite errors, it is roughly correct to say that Nongfu Spring earns less than one cent per bottle of water and less than six cents per bottle of beverage. Nongfu Spring's bottled water business provides 'water-to-mouth service,' and Meituan's food delivery provides 'food-to-mouth service,' with similar attributes. In 2019, Meituan delivered 8.7 billion food delivery orders. After deducting delivery fees, the commission per order was 0.98 yuan, and the operating profit per order was about 0.2 yuan; Nongfu Spring delivered 33.5 billion bottles of drinking water, with an ex-factory price of about 0.43 yuan per bottle and an operating profit of about 0.1 yuan per bottle. Both companies earn meager profits by providing services at the billion/ten-billion scale. The gross profit margin of the bottled water business seems high—some media exclaim 'Nature's money printer'—but the absolute gross profit per bottle is less than 3 cents, and net profit is only a few cents. Any fluctuation, such as an increase in oil prices, corrugated paper prices, road or rail freight, or labor costs, one or more of which could rise, is enough to wipe out the few cents of profit. Despite a gross profit margin as high as 60%, Nongfu Spring's drinking water business is still a low-margin business. Here's a real example: on e-commerce platforms, a sewing needle costs 3 cents, with a cost of 1 cent, a gross profit margin of 66.7%. Needle-making is both low-margin and high-margin, but understanding it as low-margin can reduce misunderstandings. Seeing high profits, everyone rushes to start a needle-making business, but with only 2 cents of gross profit, they might lose 2 cents per needle. The core competitiveness of both Nongfu Spring and Meituan's food delivery is 'making a fuss in a snail's shell.' They squeeze out profits penny by penny, then multiply by an astronomical number—8.7 billion, 33.5 billion—to enjoy billions in gross profit, leaving competitors sighing in admiration. Internet genes are a good thing. The food delivery business earns little, but the traffic it brings allows Meituan to earn 15 billion yuan in 'online marketing fees' from restaurants and hotels. In contrast, Nongfu Spring can only use the production scale, sales channels, and brand awareness built by its bottled water business to operate 'high-profit' products like tea drinks, functional drinks, and juices, earning nearly 5 billion yuan in gross profit. In 2019, the PET price was 7,074 yuan per ton, down 1,023 yuan from 2018, a decline of 12.6%. PET prices are positively correlated with international oil prices, and will inevitably decline further in 2020. Good times are coming for Nongfu Spring. Source: Huxiu APP (ID: huxiu_com), Author: Eastland Tips will be paid 400-2000 yuan once adopted.