A Once-in-a-Decade Opportunity for Consumers

After experiencing a significant downturn lasting over three years, the A-share market for food and beverage stocks has finally realized a turning point in September 2024. Among this recent surge, the beverage and dairy sectors have emerged as leaders, signaling the potential for many cyclical opportunities ahead.

The critical aspect driving this recovery is the valuation level, which has reached a ten-year lowSince November 25, for instance, the share price of Yiming Foods skyrocketed by over 170%, achieving a remarkable streak of eleven consecutive limit-up pricesIt has clearly dominated the recent market trendOther companies such as Panda Dairy reported a 37% surge, while brands like Joy Home, Huangshi Group, Junyao Health, and Vivid Shares saw increases exceeding 20%. Even larger companies like Yili and Dongpeng Beverages registered more modest gains of 4% and 18%, respectively.

Historically, witnessing such explosive growth in the beverage and dairy sectors within a short span has been uncommon over the past three years

So, what fuelled this new surge? According to market observers, a significant factor was the optimism surrounding the upcoming high-level meetings in December that were expected to focus on stimulating consumer spending.

Domestic demand, in particular, has been under pressure from infrastructure investment constraints and challenges faced by the real estate sector, which has been striving for stabilityThis context has increasingly positioned consumer demand enhancement as a key area for policy intervention.

In fact, prior to the announcement of a fiscal stimulus scale by the National People's Congress on November 8, there was intense speculation in the market about the potential for fiscal measures to stimulate consumptionNotably, over 30 food and beverage companies hit their daily price limits on November 7. However, the eventual announcement did not include direct references to consumer stimulation, which led to a significant market pullback.

On December 9, the important meeting affirmatively indicated a need to "vigorously boost consumption and comprehensively expand domestic demand," aligning with the optimistic expectations of investors.

Moreover, the beverage and dairy sector currently sits in a valuation deep dive, with a Price-Earnings (PE) ratio of 19.84, significantly below the median of 24.33 over the past decade

• Major Overhaul of the Nasdaq 100 Index
• A-Shares Soar, Semiconductor Companies Cash In!
• The Bank of Japan Should Raise Interest Rates
• Pledging Will Determine Bitcoin's Role in the Digital Economy
• How Non-Farm Payroll Data Disturbs the Market?

In contrast, sectors such as electronics, computing, non-banking financials, media, and military defense are maintaining PE ratios above 85% of their median valuations since 2018.

Additionally, outside of leading players like Yili and Dongpeng, which have market caps exceeding one hundred billion, there exists a plethora of smaller companies with market values typically in the tens of billions, making them particularly attractive under the current trend favoring lower market caps.

So, is there still hope for continued positive performance in the beverage and dairy sector?

As the industry observed, both volume and price have shown promising signs, with dividends on the horizonIn 2023, China’s beverage industry saw its market scale exceed 700 billion yuan, forming a vast playing fieldBottled water, carbonated drinks, tea beverages, juice, dairy drinks, and energy drinks represent the largest shares of the total, collectively contributing to 32%, 18%, 18%, 10%, 10%, and 8% respectively

Moreover, sports drinks and coffee beverages occupy even smaller yet significant segments.

Historically, the Chinese beverage market has experienced consistent growthBetween 2006 and 2014, all sub-segments expanded rapidly, pushing the overall market size to grow at a compound annual growth rate (CAGR) of 14.5%, with volume and price contributions of 10.9% and 3.2%, respectively.

However, during the subsequent five years (2015-2020), the industry faced a notable slowdown in sales growth, with prices stagnating as the market struggled to advanceUnlike products such as liquor, beer, and soy sauce, which enjoyed a consumer upgrade and subsequent price increases, the beverage sector experienced stagnation during this period primarily due to the digestion of excess production capacity and an observable peak in consumer demographic dividends.

It wasn’t until 2021 that a decline in price competition spurred a revival in the beverage sector, enabling a return to the 'volume-price ascendancy’ trend

From 2021 to 2023, the volume and price growth rates were recorded at 1.9% and 1.7%, respectively.

Looking ahead, it is likely that the overall beverage industry in China will maintain a moderate growth trajectory, with the 'volume-price rise' pattern expected to continue.

On the consumption volume front, China's per capita soft drink consumption stands at 71 liters, significantly lower than Japan's 189 liters, the UK’s 174 liters, and the USA’s impressive 380 litersWhile it is essential to note that such comparisons might not definitively illustrate China's soft drink market potential due to differences in eating habits and demographics, it does indicate that there’s considerable room for market penetration in the beverage sector.

According to estimates by Euromonitor, the penetration rates for bottled water and non-water beverages in China as of 2023 were only 7% and 6%, respectively, well below Japan's figures of 10% and 26%, as well as the USA's readings of 19% and 32%.

From a pricing perspective, beverages, being closely tied to everyday consumer behavior, exhibit price increases aligned with inflation levels

In actuality, from 2009 to 2023, China's retail average price increase for beverages was only 22%, significantly lower than the cumulative CPI increase of 36%. Yet, there remains a consistent upward price trend.

Furthermore, the profitability of the beverage industry shows relatively strong performance within the larger consumption sectorBy the end of the third quarter of 2024, the gross profit margin for soft drinks was 40.9%, with a net profit margin of 18.3%, trailing just behind liquor's impressive 40% margin while surpassing beer's 16.8%, flavorful fermented products' 17%, and processed foods' and snacks' 6% margins.

When it comes to dividends, the period between 2017 and 2023 saw consistently high payout ratios of above 70% for beverage and dairy companies (Shenwan). As per Wind data, the dividend yield for 2024 stands at 3.2%, which is only slightly less than the 4% for food processing but greater than the 2.5% for liquor and 1.6% for flavorful fermented products.

Therein lies the potential for China’s beverage industry to likely maintain a 'volume-price improvement' state, ensuring that profits can still be expected.

Lastly, within the expansive beverage sector worth hundreds of billions, there are relatively few standout products that have reached or surpassed the billion mark

As of 2023, only brands like Red Bull and Nongfu Spring hold market values over 200 billion, while Pepsi, Jiaduobao, Sprite, Coca-Cola, Yibao, Wangzai Milk, Dongpeng Beverage, and BaiSu Mountain hover in the billion range.

However, previously prominent products approaching the billion mark, such as Nutritional Express, Six Walnut, and Wahaha AD Calcium Milk, have faced continuous declines since 2014.

What, then, accounts for the longevity and success of beverage products in the market? It appears that longevity is attributed to products existing in substantial sub-segment markets with long life cycles, consistently meeting consumer demandsBasic rehydration products and fatigue-reducing functional drinks, catering to practical consumer needs, don’t necessitate the frequent research and development of new products; rather, companies should focus on solidifying their brand and operations for sustained performance.

On the other hand, flavor-based drinks, which hinge on consumers' leisure needs, face quicker changes in consumer preferences and loyalty, thereby requiring continuous intro of new products to maintain market presence.

This contrasts the sustainability of mid-tier and high-end drink products that are often peaking earlier and thus not perpetually in demand

For instance, brands like Yangyuan’s Six Walnut and Wahaha's Nutritional Express exemplify this scenario.

Overall, in recent years, leading products in China's beverage industry have emerged predominantly from basic and functional drink offerings, with significant examples being Nongfu Spring and Dongpeng Beverage, showcasing vastly contrasting performances compared to sweets and flavor-based segments.

Dongpeng Beverage, in particular, constitutes a remarkable underdog in A-share markets, widely recognized for its robust growth performance over the last four years.

The functional drink segment is projected to exceed 500 billion yuan, with a clear market structure defined by major players such as Red Bull and DongpengCompeting brands, including Tiandi Energy, Lehu, Zhanma, and Monster have relatively smaller market shares that cannot rival the major two.

Moreover, Dongpeng Beverage delivers remarkable value-for-money, appealing to consumers such as drivers and delivery workers who prioritize cost-effectiveness

The mainstream 500ml Dongpeng functional drink is priced at 10 yuan per liter, while Red Bull’s, Monster’s, and other competitors’ prices are significantly higher at 24 yuan, 21.2 yuan, 125 yuan, and 90 yuan per liter, respectivelyThis competitive pricing strategy has enabled Dongpeng to steadily capture market share from its rivals.

With this market framework, Dongpeng has steadily shown commendable growth and profitability, while Nongfu Spring continues to thrive thanks to the ongoing expansion within the bottled water segment and increased market share, coupled with successful products like Oriental Leaf tea beverages.

In summary, the expansive beverage and dairy market invariably gives rise to promising growth stories, particularly in segments like bottled water, functional beverages, and tea drinks, warranting keen tracking and observation from investors.

Your email address will not be published.Required fields are marked *