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Announcements Apr 29, 2020 02:41 am EqualOcean

Q1 2020 report

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Aug 10, 2020 11:46 am ·

Three Squirrels Enters into Blind Box Industry

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Analysis EO
Analysis · 2
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Analysis EO
Jul 22, 2020 01:23 pm ·

Three Squirrels Beats Mars and Mondelez in China – Initiate with Hold [2/2]

This article is part II of our analysis on Three Squirrels – check out part I before you read.  Three Squirrels pursues a supply chain that combines directly managed and outsourcing models. In the procurement stage, Three Squirrels outsources the work to large procurement managers but has established a wholly-owned subsidiary as well as a product manager mechanism to conduct quality and safety oversight.  In the production and warehousing stages, Three Squirrels recently started to run on a 'union strategy,' whereby it partners with high quality mid- and small-size manufacturers to build factories together, and these factories function both as production lines and front-end warehouses. By co-investing, Three Squirrels creates a risk and reward sharing mechanism between itself and its partners, which leads to strong communication in the supply chain while maintaining 'asset-light' business characteristics.   With the current model, we think Three Squirrels is the leading player in both efficiency and cohesiveness aspects of the snack supply chain. One concern is whether this supply chain model can still bring efficiency to Three Squirrels' rapid expanding offline sales channels. Currently, there are about 600 Three Squirrels offline stores – among them 80% are franchise stores. With the aim of expanding its total offline presence to 10,000 stores in 5 years, we expect a heavy emphasis on the franchise model, allowing independent store owners to take on the majority of responsibilities. This could mean looser communication and controls. It is still too premature to say whether Three Squirrels’ current supply chain is capable of handling offline franchising at such a scale. Channels Three Squirrels emerged as an online player in the snack industry, but due to 1. Lower online margin and 2. Larger offline market, Three Squirrels' transition to offline sales is inevitable. We will analyze both Three Squirrels' online performance as well as the upside and downside of its current offline expansion. As shown on the graph, online sales are still the major source of income for Three Squirrels, but there was a continuous margin contraction in both 2019 and Q1 2020. In 2017/2018/2019, online sales took 95%/89%/93% of Three Squirrels' revenue respectively. While established IP is one factor in online sales increases, another catalyst is increasing e-commerce penetration. This rate rose by 8% from 2016 to 2018 in upper-tier cities and by 10% in lower-tier cities. For offline channels, Three Squirrels has established directly managed and franchise stores, with a current 1 to 4 ratio among these two categories. In comparison, offline channels are able to capture at least 1.5x margin compared to online channels because consumers are less sensitive to prices in offline shopping. Specifically, directly managed stores are about 4x larger in scale and can generate as much as 8x revenue compared to franchise stores.  One upside we see in Three Squirrels' offline store is the SPA model (specialty retailer of private label apparel) in its directly managed stores. This model is originally adopted by clothing retail brands including Zara and UNIQLO, its core is to use a comprehensive store as a way to capture consumer preference and to efficiently relay downstream feedback to upstream R&D and supply chain processes. It allows brands to control inventory risks and produce a variety of products.  We think both of the above characteristics fit well with Three Squirrels' strong suits. First, the offline stores provide valuable feedback to Three Squirrels' data center and aids in quick and accurate product targeting. Second, it supports Three Squirrels’ strength in creating a variety of products by enabling effective inventory management.  On the downside, the scale of offline channels for Three Squirrels is still limited. It is facing immediate competition with Bestore, the same market cap snack retailer that started in offline sales. Currently, Bestore has a much more mature offline franchising system, where the brand franchisees serve as investors, and Bestore controls supply and operating aspects of the stores. On the other hand, Three Squirrels' franchising system puts franchisees as the investors, operators and main risk takers and the brand itself only as a supplier. We think Bestore’s model can bring more quality and can better ensure a unified brand image than Three Squirrels at this stage. So, even with success in the supply chain, Three Squirrels' large offline scaling can raise some concerns. Valuation We drive our price target of CNY 72.5 from a three-stage DCF methodology, assuming a WACC of 9.87%. Our price target implies a 6% upside – therefore, Initiate with a Hold rating. The revenue growth forecasts for 2020/21/2022 are 26%/32%/35% reflect Three Squirrels' ramping up offline channel expansion and leadership in online distribution and horizontal expansion into categories. We expect short-term gross profit margin will improve slightly due to a refined supply chain efficiency and better inventory management, growing to 28.0% in 2020 from 27.8% in 2019. Still, the launch of new products and brick-and-mortars stores may pose challenges here. We also expect the net margin to grow from 2.3% in 2019 to 3% in 2024 due to improving operating efficiency; however, we note that net margin can be decreasing from 2020 and 2024, to reflect potential high competition against offline leaders like Bestore. We apply a 15% medium-term growth, a 2% perpetual growth rate. Our bull case and bear case scenario valuations suggest a 33% upside and 40% downside, respectively.

Analysis EO
Analysis · 2
report
Analysis EO
Jul 22, 2020 01:20 pm ·

Three Squirrels Beats Mars and Mondelez in China – Initiate with Hold [1/2]

In the past few years, rising Chinese domestic brands have been winning millennials over with an array of popular western snacks, such as Oreo biscuits by Mondelez and button-shaped M&Ms from by Mars. Local snack retailers capitalize on the rise of online purchase habits, leveraging understanding of customers and building an edge over overseas competitors.  EqualOcean has been following the Chinese snack market and leaders, including Three Squirrels, Bestore, Juewei, among others, and we plan to release a research series on the companies. Our coverage of Three Squirrels is the first in the series. We think the company is well-positioned to capture the potential of an omnichannel pivot, turning away from the purely-online channel to expand horizontally and broaden its product mix.  Business overview Three Squirrels (300783:SZ) is a leading online snack retailer in China. The company was founded in 2012 by Zhang Liaoyuan. With nut products being the backbone of Three Squirrels’ sales, the company has seen exponential topline growth since its inception.  Competence For hyper growth retailers that are born online, efficiency and cohesiveness in all streams of the production and selling process are still the keys that keep businesses alive and drive growth in the long term. In this analysis, we want to examine three streams of Three Squirrel’s current business model, including R&D, Supply Chain, and Channels. R&D China culture favors the snack – for food mad people, what could be better than making a portable diversion of your favorite activity.  As snack varieties have multiplied over the years, the ability to create best sellers (爆款) on internet platforms has become crucial to revenue generation for snack retail brands. For Three Squirrels, it was crucial that the brand was able to ride an explosive topline growth on the trend it created with its nut products in the first few years.  The success of the current generation of snack sellers can be attributed to innovation, quality, and advertisement. The latter two factors will be covered in separate sections. Here we will focus on how Three Squirrels is bringing its innovative products to light.  There are two distinct elements we see in Three Squirrels’ snack R&D effort: 1. It has been consistently increasing its R&D spending as a percentage of revenue; 2. With its topline and bottomline expansion, Three Squirrels has partnered with world-renowned brands to enhance its upstream efficiency.  We think both initiatives from Three Squirrels are going to build an economic moat for the company. In terms of increasing R&D spending, this could help Three Squirrels to quickly develop fresh product ideas and the technology needed to preserve these products. The former is crucial as Three Squirrels taps into a larger and more varied consumer base. In terms of partnership, Three Squirrels established a cooperation (in 2018) with Danisco – a flavoring subsidiary of international conglomerate DuPont – to enhance the flavor of its new products. These two R&D edges enabled the company to quickly innovate and expand its portfolio of snacks. For instance, its new product “hand[sl1] -torn bread” (手撕面包) became a major revenue-generating force in 2019, extending Three Squirrels’ snack sales beyond nut products.  There is a concern associated with Three Squirrels’ R&D effort – its ability to meet consumers’ tastes across regions. As of now, the company's top source of revenue is the Eastern and Southern parts of China. It has a lower presence in Northern parts of China, such as Beijing. So, tapping into a profitable market like this in the future will be a challenge for Three Squirrels’ R&D team.  Supply Chain There are a few catalysts that are putting the supply chain in the center stage of this game:  On the demand side, as people from age 20 to 35 become the core consumers of snacks, they demand a higher variation and higher quality in snacks. However, there is an inherent tradeoff between shelf-life and quality of snacks. This means snack sellers need to have a supply chain capable of producing new snacks quickly and bringing snacks to shelves in shorter periods of time, in order to gain market share. Supply chains also serve as a connecting point, as feedback flows from consumer end to upstream R&D. Having a cohesive supply chain is vital for companies to capitalize on current trends, expanding into new markets, and controlling inventories.  For ‘Tao Brands,’ intense competition and a high level of price-sensitivity in online platforms are squeezing out margins. Sustainable long-term profit depends on a combination of online and offline sales. Multi-channel sales are built on the basis of a flexible supply chain infrastructure.     This article is part I of our analysis on Three Squirrels. Please continue to part II.

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Announcements
May 28, 2020 12:22 pm · CNINFO

Three Squirrels: Change of Employee Representative Supervisor

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Announcements
May 28, 2020 12:12 pm · CNINFO

Three Squirrels: Li Feng as Chairman of the Second Supervisory Board

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