Nongfu Spring

Long HKG:9633

October 3rd, 2024

INTRODUCTION

Nongfu Spring is the largest bottled water company in China. Established in 1996, its major products include bottled water, tea beverages (similar to Pure Leaf), functional beverages (similar to Vitamin Water and Propel), and juice drinks (similar to Tropicana and Naked). Nongfu Spring’s scale, supply chain, brands and Founder/CEO allow it to dominate now and in the future.

Note: Once again I prove my inability to time the market! This should have been posted a couple of weeks ago. My average cost is HKD 27.93, I hope you get the same opportunity again soon

.

Circle of competence

Nongfu Spring is a textbook example of a business at the bottom of Maslow’s Hierarchy of Needs. Perhaps, the only thing more essential than water is air.

In China the need for water is dramatic. China has ~18% of the global population and only 6% of the world’s total freshwater supply. At 2,018 cubic meters per year per person it is 75% less than the global average. 

Worsening the situation, receding glaciers continue to reduce the overall supply and river pollution decreases the amount of water which is actually drinkable. Compounding matters further, the distribution of drinkable water is challenging. Approximately 80% of freshwater is concentrated in Southern China and Chinese citizens continue to move from rural areas to cities. This challenges the government and companies to distribute water across the whole country and support people with on-the-go lifestyles. All of these factors make a branded drinking water manufacturer and distributor highly valuable.

Economic Castle

The following are based on 2023 year end:

• High ROE

  • ROE of ~42%

• High free cash flow conversion 

  • ~104%

• High margins

  • Gross margin of ~60%

  • Operating margin of ~37%

  • Net profit margin of ~28%

• High liquidity

  • Cash position is ~57% of annual revenues

  • Cash is 49% of total assets

• Minimal debt

• High growth

  • 4 year compounded revenue growth of 15%

  • 4 year compounded profit growth of 25%

The growth runway in China is very long. Nongfu Spring can 10x it’s profits by realizing the full potential of its four main products because of the following factors:

• China’s bottled water consumption per capita can grow 3-5x to meet the United States and/or Mexico.

  • Continued expansion into existing sales network in China

  • Expansion of new sales channels in China including vending machines (more on this later). It is very important to note, a proprietary network of vending machines would give Nongfu Spring a competitive advantage for introducing new beverage and snack products

  • Discretionary incomes rise as GDP per capita rises

  • Changing lifestyles from trends like urbanization continue to provide a tailwind for products like bottled water

  • High terminal growth rates. Water industry growth rates in advanced economies are still mid single digits

• Continue growth in core products excluding water

  • Teas

  • Functional and sports

  • Juices

• Operating leverage

  • As of 2019, the Nongfu Spring’s prospectus stated many production facilities were only at 50-60 percent capacity utilization. Some were much lower.

• Growth in beverage categories which aren’t core products already

  • Coffee

  • Soda

  • Dairy

  • Infant and kids nutrition

  • Adult supplemental nutrition

  • Energy

  • Alcohol. Unlikely given management’s health focus.

• Growth in food categories

Moat