Nongfu Spring Makes Major New Investment Amid Profit Pressures

Key Takeaways:

• Nongfu Spring will invest 5 billion yuan with the city of Jiande in Zhejiang province to build a new production base for its drinking water and other beverage products 
• With gross and net profit margins of 60% and 28%, respectively, the company far outperforms its Mainland Chinese peers in terms of profitability

By Ken Lo

After consolidating its place as leader of China’s bottled water market, Nongfu Spring Co. Ltd. (9633.HK), known for its trademark red-and-green bottles of drinking water, is flowing into a major new investment in its home province of Zhejiang. 

The company announced on Dec. 31 it will invest 5 billion yuan ($698 million) over five years with the city of Jiande after receiving 1,000 mu (667 square meters) of industrial land for the project. With a cash and bank balance of 24.7 billion yuan at the end of last June, the company has more than ample resources to cover such a massive investment.

The Jiande project will produce and process drinking water, beverages and related products and be built in two phases, the first covering an area of about 700 mu and the second the remaining 300 mu, Nongfu said. It will rely on natural water resources from Qiandao Lake near the provincial capital of Hangzhou.

Nongfu made a splash with its Hong Kong listing in 2020, raising HK$9.38 billion ($1.2 billion) in one of the year’s biggest such fundraisings for a leading consumer brand. At the time, it said it would spend HK$1.88 billion of the proceeds to acquire production facilities and build new plants, with HK$440 million of that still unspent at the middle of last year. That fund pool is expected to run dry by the end of this year, partly to finance the new Jiande project.

China’s bottled water market looks like a strong long-term bet, currently supplying just 15.5% of the nation’s drinking water needs. But the sector is also brimming with competition from both local players and also global giants like Coca Cola KO and Nestle (NESN.SW), which have also worked for years to build up their brands and gain consumer trust for quality.

Nongfu isn’t only the Chinese leader in terms of sales, but also has an enviable gross margin of around 60%. It has attained that level by banking on its premium image as a purveyor of high-quality products running the range from drinking water, to a growing slice of its business that comes from other drinks like bottled teas, juices and soft drinks. 

Its revenue from water products accounted for 51% of its total in the first half of last year, down 5.6 percentage points from a year earlier, while tea and functional beverages accounted for 25.8% and 12% respectively. Its diversified products allow it to leverage its well-regarded brand over a broad range of drinks, while also reducing its reliance on a single product.

Led By China’s Richest Man

Nongfu is also known for its low-key founder and Chairman Zhong Shanshan, who has topped Forbes China Rich List for the last three years, with a fortune of $60.1 billion in the latest 2023 edition.

In the global beverage realm, only the century-old Coke and PepsiCo PEP come close to matching Nongfu in terms of profitability, with gross margins of 61% for Coke and 54.5% for Pepsi in last year’s third quarter. That’s quite impressive for Nongfu, whose history is much briefer, dating back to its founding just 28 years ago.  

That’s not to say that no one in China comes close to Nongfu, since bubble tea seller Nayuki (2150.HK) also boasted a gross margin of 68.2% in the first half of last year. But Nayuki’s net margin was just 2.7% after taking other factors into account, while Nongfu’s was far higher at 28.2%.

Nontfu also leaves two other leading local beverage makers, Tingyi (0322.HK) and Uni-President China (0220.HK), in the dust. Tingyi’s beverage segment recorded 24.3 billion yuan in revenue in the first half of last year and nearly 1 billion yuan of profit, translating to a net profit margin of about 4%. Uni-President was a bit better, with a profit of 998 million yuan on 9.26 billion yuan in beverage revenue, yielding a net profit margin of 10.8%, still well behind Nongfu.

That said, rising costs have been a headache for Nongfu lately, especially due to rising plastic costs related to high oil prices. The company’s 2020 IPO prospectus showed that raw materials and packaging materials are the two largest items in its cost of sales, accounting for 58% and 14.6%, respectively. Such costs are mainly for the production of PET plastic bottles, caps, labels and beverage ingredients. PET plastic, in particular, accounted for 28.2% of the company’s cost of goods sold.

Hit By Rising Oil Prices 

Geopolitical factors have lifted international oil prices to high levels since the start of the Russia-Ukraine war. The cost of PET, as a crude oil downstream product, plays a big part in determining Nongfu’s profitability, far more than the cost of water that makes up a much smaller percentage of the cost of each bottle sold. That means the major new expansion in Jiande will have limited impact on improving the company’s profitability.

At the beginning of 2022, Nongfu executive director Zhou Zhenhua disclosed that cost pressures “exceeded the level that the enterprise can take by itself.” Despite initially trying to absorb the higher costs itself, it ultimately had to bow to market pressure and do the inevitable.

As a result, Nongfu raised the price of its 19-liter water jugs from 20 yuan to 22 yuan in Hangzhou last February, after making a similar adjustment in early 2022 that saw it raise its prices in Shanghai from 26 yuan to 28 yuan. After the hike, Nongfu’s profit jumped 25.3% in the first half of last year, slightly outpacing its 23.3% revenue growth.

Despite its stellar performance, investors may be wary of Nongfu’s high stock price, which gives it a lofty forward price-to-earnings (P/E) ratio of 44 – a figure that looks more suitable for a high-growth tech company than a low-tech bottled water seller. The figure is more than double the P/E of 21 times for both Coke and Pepsi, suggesting that Nongfu’s stock could contain quite a few bubbles in addition to the company’s renowned beverage products.

This article is from an external contributor. It does not represent Benzinga's reporting and has not been edited for content or accuracy.