Subscribe

Announcements May 28, 2020 12:22 pm EqualOcean

Three Squirrels: Change of Employee Representative Supervisor

Analysis EO
Analysis · 2
report
Analysis EO
Aug 11, 2020 01:37 am ·

The Tale of Chinese Flavor Continues – Initiate Bestore with Hold

Bestore (SHA: 603719) was trading at 69.4 CNY as of August 7th, with P/E of 78.44x and a market cap of 28.47 billion CNY. As a rising local flavored Chinese snack brand in recent years, Bestore has earned its name in offline sales and is currently expanding its presence online, which was an opposite path compared to another giant in this specific field – Three Squirrels. Coming off a great year in 2019 with 21% year-over-year net income growth and 25% EBITDA growth, Bestore has met some setbacks during Q1 2020 due to disruption in offline sales and supply chain. Increases in online sales became the backbone for its sales growth at the beginning of this year – Bestore recorded a 4.16% top-line growth in Q1 2020. As the macroeconomy recovers quickly in post-pandemic China, we expect to see Bestore’s top-line growth to be in line with Q3 and Q4 compared to last year. Premiumization faces quality concerns Bestore started in Wuhan and operates mainly in central parts of China. Bestore has been continually revamping its brand image and expanding its presence to other parts of China. Now, it is aiming to shape its brand as a high-end Chinese snack brand, and we can see its effort through its logo change and its sponsorship to a popular TV show series in China with a backdrop of life among elite white-collar lawyers. This premiumization has put less pressure on discounting prices on Bestore. Combined with a large offline presence, Bestore maintained a relatively high gross margin of 31% in 2018 and 2019, whereas Three Squirrels was consistently 3% lower. However, we view this success in downstream branding and sales activities faces an inherent concern in Bestore’s upstream quality. Similar to Three Squirrels, Bestore has thousands of SKUs and is constantly putting out new ones. The variety and fast-changing nature set a high standard for product quality and safety, especially for a premium brand like Bestore. Here, we see two risks that might threaten Bestore’s premium branding in the long term: 1. Little spending and focus on R&D can hurt product quality, 2. OEM models in manufacturing could cause more food safety concerns. Regarding our first point, Bestore has been investing less in R&D compared to its peers. In both 2018 and 2019, Bestore’s R&D spending was <0.4% of COGS, which was lower compared to Three Squirrels’ ~0.5%. We should also notice that this percentage was calculated under the condition where Bestore had a higher gross margin. As the market for fresh snacks continues to expand, the ability to bring innovative snacks to consumers will remain a key competing element in the future. Being a premium brand, lack of effort in R&D can potentially fail consumers’ expectations. The second point regarding Bestore’s manufacturing system also brings some concerns to food safety. In the past, consumers have reported food safety issues regarding Bestore’s product, and some of the issues were even health-damaging. These problems can trace back to the manufacturing process. In our opinion, Three Squirrels is a more mature player in this aspect. In terms of manufacturing, Bestore runs on OEM, and Three Squirrels runs on a partnership process, where it co-invest in factories alongside manufacturers. We see Three Squirrels being able to connect with the manufacturers more closely and bring standards to the manufacturing phase more effectively, therefore limiting the risk associated with food safety. Efficient downstream creates a safety net for expansion Several trends in downstream snack retailing are 1. Small retail stores are being overtaken by larger stores opened in major shopping districts. 2. Online retailing is growing at a rapid speed while offline retail still seems to be a long term stapler for snack companies. 3. Synergies between various distribution channels are emerging, but there are still big potentials. As for Bestore, we think it is reacting very quickly to shifts in the downstream landscape. In recent years, it is pursuing rapid offline expansion by 1. Shutting down smaller stores and opening large stores in major shopping districts. 2. Increasing the proportion of franchise stores compared to direct-managed stores. In 2019, Bestore closed 60 direct-managed stores and opened almost 300 franchise stores, echoing its plan. To this aspect, we see a trade-off between quality and quantity. As direct-managed stores generate higher margins, increasing franchised stores can harm overall per store income - Bestore’s offline year-over-year per store revenue increased by 11%, 6%, and 2% in 2017, 2018, and 2019 respectively. However, this sacrifice in per store income also brings the ability to expand more quickly (stats here). Here, we want to point out two important aspects of Bestore’s offline operation: 1. It can efficiently manage its inventory, with a turnover of ~60 days compared to nearly 2x of its peers. 2. Its franchise model reaches a great risk and reward balance between the company and franchisees, which makes the model highly scalable. Based on the aforementioned two characteristics, we see that Bestore can be greatly benefitted from a quick expansion strategy from a top-line growth standpoint. In addition, with Bestore emphasizing on growing its data and integrating technology tools in all streams, we see that offline stores can also add value by serving as reflection points on consumer preference and help Bestore to better manage its multi-channel operation. As for online sales, we see Bestore’s sales composition reflect the growing online fresh snack sales. In 2019, online sales took ~50% of Bestore’s total sales, and this is a result of Bestore’s rapid expansion in online channels. Under current trends, we see that online sales have the ability to reach a wide consumer base quickly and are less subject to extraneous circumstances such as COVID-19, but the competition and high price sensitivity online also put pressure on snack brands’ margins. So, by having both high margin offline channels and high resilience online channels in its portfolio, we see that Bestore will be less subject to bottom-line risk. With promising channel development, there are two concerns to Bestore’s channel strategies. The ability to attract franchisees presents one risk to Bestore’s expansion plan. COVID-19 brings hard hit to offline sales and the decreasing sales per unit in stores due to increasing competition from other brands and even its own stores and stretching franchises timeline to recover their initial investments. (With beverage retailers such as Naixue Tea, we have seen less motivation on franchisees due to decrease in sales). Subsequently, another long term problem we see from Bestore’s expansion is the consumer retention issue. Among its online and offline consumers, only 20% of the people overlap, as most offline consumers make their purchases based on sentiments rather than habits. Relating back to Bestore’s premiumization strategy, although Bestore has been using it to build differentiation among snack brands, the lack of R&D and quality differentiation might not justify its price in the long term, and therefore not being able to retain customers. Valuation We drive our price target of CNY 70.80 per share from a three-stage DCF methodology, assuming a WACC of 6.11%. Our projection implies a 1% upside, which is in line with the current market price - therefore, initiate with a Hold rating. Our revenue forecasts for 2020/21/22 are 16%/30%/20%, reflecting a downward pressure on offline sales due to COVID-19 in 2020, and a steady offline store and online sales growth in 2021 and 2022, similar to the scale in 2019. We expect gross margin will take a hit in 2020 due to COVID-19, and we expect overall gross margin will moderately rise to reflect a mixture of increase in margin through online and group sales and decrease in margin through franchise store expansion – growing from 29.6% to 30.5% and 30.7% in 2020/21/22 respectively. We also expect the inventory turnover will remain high at 66.9 days of 2019 going into 2020/21/22, as increasing offline stores and sales channels will pose more significant challenges for inventory management. We apply a 10% medium-term growth rate for 6 years, a 1% perpetual growth rate by referencing more mature global snack brands including Mondelez and PepsiCo. Our bull case and bear case scenario valuations suggest a 31% upside and 33% downside, respectively. Regarding our valuation, we would also place caution on our WACC. The beta is currently 0.55, and if market sentiment shifts significantly in any way, this can further discount our target price. If Bestore also begins to employ more debt financing, we can also expect a higher WACC, and therefore a lower target price.

Briefing
Briefing · 1
Briefing
Briefing · 1
Briefing
Briefing · 1
Briefing
Aug 10, 2020 11:46 am ·

Three Squirrels Enters into Blind Box Industry

Briefing
Briefing · 1
Briefing
Briefing · 1
Analysis EO
Analysis · 2
report
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.

Briefing
Briefing · 1
Briefing
Briefing · 1
Briefing
Briefing · 1
Briefing
Briefing · 1
Briefing
Briefing · 1
Briefing
Briefing · 1
Briefing
Briefing · 1
Briefing
Aug 11, 2020 06:05 pm · TechWeb

Alibaba to Provide Services to Total SA's China Business

Briefing
Briefing · 1
Briefing
Briefing · 1
Briefing
Briefing · 1
Briefing
Aug 11, 2020 02:34 pm · EO Company

Pinduoduo Ranked in the Top 10 Apple Store Downloads in July

Read more