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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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Analysis · 1
Analysis
Dec 24, 2019 12:00 am · 36Kr

Three squirrels opened 10,000 stores

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Analysis · 1
Analysis
Jun 24, 2019 07:59 pm · The above information is fromPingan Securities, with source link: stock.pingan.com. Please contact this company if full report is needed.

The twists and turns of the IPO have been postponed, Three Squirrels have a bumpy KOL road!

Analysis EO
Analysis · 2
Analysis EO
Apr 2, 2019 07:00 pm ·

Chinese Consumers Are Nuts for Three Squirrels, A Unique Nut Brand

We are initiating coverage of Three Squirrels Inc. (三只松鼠) with a positive investment view. Founded in 2012 by Zhang Liaoyuan (章燎原), Three Squirrels is a leading snack brand that achieves USD 1.5 billion sales in 2018 through selling nuts, seeds, dried fruits and other snacks. Three Squirrels is not only the first food brand tapping into e-commerce, but is also currently the largest snack retailer on major Chinese online retail sites. The company has successfully turned a relatively mundane product into a successful and recognizable domestic brand. Investment positives Unique brand IP creates customer loyalty Tmall, the biggest revenue stream for Three Squirrels (64% of sales come from Tmall), impressively showed that searches for "three squirrels" or "three squirrel flagship stores" quadruple searches for "nuts" and more than double searches for "snacks". Sales volume of Three Squirrels has been ranking #1 in the “snacks/nuts” category from 2014 to 2018. Furthermore, Three Squirrels products have an average rating of 4.8 out of 5 on the Tmall website, compared to the industry average of 3.9 out of 5. The positive reputation of Three Squirrels is likely driven by multiple branding strategies which its competitors lack: 1) Unlike traditional nut suppliers, who emphasize savory tastes and unique suppliers, Three Squirrels acts more like a product manager, using an exclusive, customer-friendly trademark to make customers remember the brand even at first glance. Chinese internet giants are known for successfully using animals in marketing, including Tencent’s penguin, JD’s puppy, Taobao’s cat and Ctrip’s dolphin. Three Squirrels has adopted a similar strategy - using three cartoon squirrels to give the nut brand a “warm, approachable personality” and to narrow the distance between the brand and its end-consumers. 2) The company uses squirrel images throughout the customer experience, reinforcing them on online stores and customer service accounts as well as physical store decor and packaging design. Throughout these venues, customers are consistently met with squirrel imagery. 3) Since 2017, the company has been producing 3D animation and mobile games, as well as investing in a theme park, all under the name of “Three Squirrels”. In particular, Seasons 1 and 2 of the animated “Three Squirrels” series has achieved viewership rates of over 300 million on the internet. We expect that the unique IP will continue to act as a core competitive advantage and that consumers will increasingly associate “Three Squirrels” with nuts. Omnichannel to broaden customer reach The internet is a valuable starting point for Three Squirrels to distribute snacks due to the higher efficiency the internet offers in comparison to traditional offline channels. Three Squirrels seized e-commerce opportunities in 2012, securing the first-mover advantage. While the overall market in nuts, dried fruits and other snacks has grown slowly over the last few years, sales of nuts, dried fruits and other snacks on Tmall has expanded significantly, with CAGRs of 55%, 37% and 55% from 2014 to 2016. As of June 2017, the number of Three Squirrels purchasers exceeded 45 million and the products had an average repeating purchase rate of over 35%. In the snacks industry which has a low barrier for entry, Three Squirrels has the scale. Nevertheless, with only 11% penetration in the huge overall nut industry, future growth of the brand will largely come from offline channels. On November 11th, 2017, Three Squirrels realized CNY 522 million day sales, indicating a 3% YOY growth. This was significantly less than the 91% YOY growth in 2016. Given that more than 10% of annual sales would come from this Chinese shopping festival, the disappointing sales figure was a wake-up call for the management team. Since then, Three Squirrels decided not to solely rely on e-commerce, instead significantly expanding its offline networks. The company chose second and third-tier cities with relatively low online shopping penetration rates, including Wuhu, Suzhou and Nanjing. By the end of 2018, 45 self-operated stores had propped up, primarily located in Southeast China and averaging over CNY 8 million (USD 1.2 million) annual sales per store. The company expects to open 150 self-operated stores in 2019, in addition to 10,000 franchise stores by 2024, partnering with Alibaba and Suning’s offline channels. Diversified product offerings to expand addressable markets and margins While nuts are still the main source of revenue for Three Squirrels, nut sales dropped from 88% of total sales in 2014 to lower than 80% in 2018. The company has significantly broadened its food portfolio by introducing products with lower ASP but higher margins. Berries and herbal tea, in particular, have margins of over 40%. Although the squirrel image is more related to nuts, Three Squirrels has successfully made the transition to Western-style bakery items. For example, the company sells bread and cakes with 45-day expiration dates, differing from the 7-day or 6-month expiration date cakes currently produced by existing players. Three Squirrels’ bread category grew at over 100% in 2018, realizing over 400k of monthly transactions on Tmall, well exceeding the industry leader Panpan Bread (100k monthly transactions) and Daliyuan (20k monthly transactions). This success was clearly driven by stronger Internet distribution channels. As of now, Three Squirrels has over 200 SKU. Going forward, we trust in the company’s ability to introduce new products, diversifying their portfolio with creative, fun, and innovative snacks. It is prudent to say that the existing brand will bring consumers to other food categories at lower customer acquisition costs, resulting in a positive margin impact. Investment risks Food safety issues caused by excessive reliance on OEM and insufficient quality control Three Squirrels have entered the IPO listing queue three times so far but unexpectedly suspended the process twice, likely due to its violation of food safety standards. According to company prospectus, 7 consumers sued Three Squirrels for discovering worms in its dried fruit products. The National Quality Inspection Department also found that several nuts products showed excessive fungus. Such incidents were likely caused by the large reliance on OEM production, a model allows Three Squirrels to meet surging production demands but raises concerns on food quality. In the event that Three Squirrels fail to inspect those issues or fail to maintain food quality during the manufacturing, storage and transportation process, the company may experience both headwinds on financials and a further delay in IPO. Slower-than-expected growth due to intense competition and commoditized products As mentioned before, Three Squirrels saw its revenue significantly slowed down in 2017 due to shifting in channel preference toward offline, before posting a strong rebound in 2017. Although the current omnichannel business model makes it more competitive in the market, fierce competition remains a source of risk as competitors such as Be & Cheery, BESTORE and Daliyuan are aggressively leveraging both online and offline channels to take on a greater market share. Given that the types of products and pricing are very similar across these brands, future growth will mainly come from channels and brand effects. TAM and competitive landscape The relatively mature and stable snack industry was estimated at CNY 485 billion (USD 72 billion) in 2017, with a CAGR of 6% in the past 6 years, according to Guohai Securities. Benefiting from the secular growth of e-commerce, snack sales have partially shifted from offline mom-and-pop shops and retail stores to online venues. The online penetration grew to 11% in 2017. Assuming the online penetration of snack sales will grow at the current pace, reaching 15% by 2022, the online addressable market for Three Squirrels is approximately CNY 93 billion (USD 14 billion). According to Sealand Securities, the CR3 of the Chinese online snack sector was 23% in 2018. The three leaders were Three Squirrels, Be & Cherry and BESTORE, with respective market shares of 11%, 7% and 5%. While snack industry has a low barrier to enter, the sector leaders are benefited from scale advantages, which allow them to develop additional barriers (for instance, allocating more capital on marketing, developing more distribution channels, increasing warehouses and logistic centers, etc) Financial outlook Top-line: Revenue grew at 121% and 116% in 2016 and 2015, respectively. We expect the top-line momentum to be driven by new snack offerings and offline expansion. Risks come from potential pricing pressure, as we do not see meaningful differentiation across Three Squirrels, Be & Cherry and BESTORE from a product perspective. Gross margin: Most companies in this sector are running low margins (under 50%). COGS has declined significantly from 76% of total sales in 2014 to 70% in 2016, driven by higher ASP and lower material costs from suppliers. As a result, gross margin has been improving at ~300bps per year from 2014 to 2016. We see GM to continue to expand mainly due to the economy of scale and the addition of higher-margin products. We believe the 35~40% gross margin, comparable to the industry average, is achievable in the long-term. Sales & Marketing: The largest operating expenses come from Sales & Marketing which took 21% of total revenue in 2016. The number was slightly lower than the industry average of 23% and has been declined by ~400bps in 2 years, driven by lower logistics fees, marketing expenses, platform service fees and employee salaries as % of the total revenue. We see the S&M/Revenue to continue to drift lower as the top-line builds scale. Valuation based on comparable public companies: With similar business models and financial profiles, we believe Hao Xiang Ni (the parent company of Be & Cheery), Toly Food and Qiaqia Food are comparable companies. Based on the average FY18 P/S of 3.2x and average FY19 P/E of 2.7x forecasted by major brokers, we believe Three Squirrels could be worth around CNY 30 billion or USD 4.5 billion given its estimated FY18 sales of USD 1.5 billion. Business overview Products: Capturing the growing trend among Chinese consumers of consuming nutritious and healthy snacks, Three Squirrels mainly offers the following items: Nuts: pistachios, Hawaiian nuts, Badam nuts, pine nuts, almonds, pecans, peanuts, etc.; Desserts: bread, small cakes, cookies, popcorns, chocolates, etc.; Dried fruit: dried mango, dried strawberry, dried durian, dates, raisins, etc.; Meat: beef sticks, pork chops, etc.; Drinks: coffee with nuts, herbal tea, etc. Supply chain: Nuts are either sourced domestically or imported from the U.S., Brazil and Australia. They are then processed in China and other Asian countries and sent to one of three logistics centers in Beijing, Wuhu or Guangzhou (a new logistics facility in Chengdu is currently under construction). Freshness is one of the most important factors in food, and Three Squirrels relies on technology and information system to keep the products fresh. As an added measure, they also deliver products to customers within 60 days of being produced. Online channels: 1) ~70% of sales come from DTC channels, including Three Squirrels flagship stores on Tmall and JD.com in addition to Three Squirrels mobile app. 2) ~25% of sales come from third-party online distribution. The company partners with the primary Chinese e-commerce platforms including Tmall, JD.com, Suning.com, No.1 Mall and Dangdang.com. These platforms purchase Three Squirrels products and in turn distribute them to end consumers. Offline channels: 1) Self-operated stores: There are 45 self-operated stores called “Three Squirrels Feeding Store” and the number is expected to rise to 150 by the end of 2019. The entire store looks like a forest; pine trees and small squirrels are integrated into every corner. Other than selling snacks, the stores also sell products that are not available on the Internet, including phone cases, school bags and pillows with the squirrel logos. 2) Franchise stores: Franchise stores are expected to reach 10,000 in 5 years (open 5 stores per day on average). In order to maximize the franchise stores, Three Squirrels does not charge franchise fees or management fees and removes 90% of rules. Shop owners will have the freedom to personalize franchise stores based on their own preferences, in addition to designing exclusive promotional activities. 3) Partnership with Suning and Alibaba offline stores: Three Squirrels also collaborate with Alibaba and Suning to have the snacks sold in their physical stores. Doing so can not only fasten Three Squirrel's offline expansion process, but also allow it to take advantage of these tech giants’ logistic systems and broad customer base.   *Please note that all data was sourced from Three Squirrel's prospectus unless otherwise stated.

Analysis EO
Analysis · 2
report
Analysis EO
Apr 2, 2019 07:00 pm ·

Chinese Consumers Are Nuts for Three Squirrels, A Unique Nut Brand

We are initiating coverage of Three Squirrels Inc. (三只松鼠) with a positive investment view. Founded in 2012 by Zhang Liaoyuan (章燎原), Three Squirrels is a leading snack brand that achieves USD 1.5 billion sales in 2018 through selling nuts, seeds, dried fruits and other snacks. Three Squirrels is not only the first food brand tapping into e-commerce, but is also currently the largest snack retailer on major Chinese online retail sites. The company has successfully turned a relatively mundane product into a successful and recognizable domestic brand. Investment positives Unique brand IP creates customer loyalty Tmall, the biggest revenue stream for Three Squirrels (64% of sales come from Tmall), impressively showed that searches for "three squirrels" or "three squirrel flagship stores" quadruple searches for "nuts" and more than double searches for "snacks". Sales volume of Three Squirrels has been ranking #1 in the “snacks/nuts” category from 2014 to 2018. Furthermore, Three Squirrels products have an average rating of 4.8 out of 5 on the Tmall website, compared to the industry average of 3.9 out of 5. The positive reputation of Three Squirrels is likely driven by multiple branding strategies which its competitors lack: 1) Unlike traditional nut suppliers, who emphasize savory tastes and unique suppliers, Three Squirrels acts more like a product manager, using an exclusive, customer-friendly trademark to make customers remember the brand even at first glance. Chinese internet giants are known for successfully using animals in marketing, including Tencent’s penguin, JD’s puppy, Taobao’s cat and Ctrip’s dolphin. Three Squirrels has adopted a similar strategy - using three cartoon squirrels to give the nut brand a “warm, approachable personality” and to narrow the distance between the brand and its end-consumers. 2) The company uses squirrel images throughout the customer experience, reinforcing them on online stores and customer service accounts as well as physical store decor and packaging design. Throughout these venues, customers are consistently met with squirrel imagery. 3) Since 2017, the company has been producing 3D animation and mobile games, as well as investing in a theme park, all under the name of “Three Squirrels”. In particular, Seasons 1 and 2 of the animated “Three Squirrels” series has achieved viewership rates of over 300 million on the internet. We expect that the unique IP will continue to act as a core competitive advantage and that consumers will increasingly associate “Three Squirrels” with nuts. Omnichannel to broaden customer reach The internet is a valuable starting point for Three Squirrels to distribute snacks due to the higher efficiency the internet offers in comparison to traditional offline channels. Three Squirrels seized e-commerce opportunities in 2012, securing the first-mover advantage. While the overall market in nuts, dried fruits and other snacks has grown slowly over the last few years, sales of nuts, dried fruits and other snacks on Tmall has expanded significantly, with CAGRs of 55%, 37% and 55% from 2014 to 2016. As of June 2017, the number of Three Squirrels purchasers exceeded 45 million and the products had an average repeating purchase rate of over 35%. In the snacks industry which has a low barrier for entry, Three Squirrels has the scale. Nevertheless, with only 11% penetration in the huge overall nut industry, future growth of the brand will largely come from offline channels. On November 11th, 2017, Three Squirrels realized CNY 522 million day sales, indicating a 3% YOY growth. This was significantly less than the 91% YOY growth in 2016. Given that more than 10% of annual sales would come from this Chinese shopping festival, the disappointing sales figure was a wake-up call for the management team. Since then, Three Squirrels decided not to solely rely on e-commerce, instead significantly expanding its offline networks. The company chose second and third-tier cities with relatively low online shopping penetration rates, including Wuhu, Suzhou and Nanjing. By the end of 2018, 45 self-operated stores had propped up, primarily located in Southeast China and averaging over CNY 8 million (USD 1.2 million) annual sales per store. The company expects to open 150 self-operated stores in 2019, in addition to 10,000 franchise stores by 2024, partnering with Alibaba and Suning’s offline channels. Diversified product offerings to expand addressable markets and margins While nuts are still the main source of revenue for Three Squirrels, nut sales dropped from 88% of total sales in 2014 to lower than 80% in 2018. The company has significantly broadened its food portfolio by introducing products with lower ASP but higher margins. Berries and herbal tea, in particular, have margins of over 40%. Although the squirrel image is more related to nuts, Three Squirrels has successfully made the transition to Western-style bakery items. For example, the company sells bread and cakes with 45-day expiration dates, differing from the 7-day or 6-month expiration date cakes currently produced by existing players. Three Squirrels’ bread category grew at over 100% in 2018, realizing over 400k of monthly transactions on Tmall, well exceeding the industry leader Panpan Bread (100k monthly transactions) and Daliyuan (20k monthly transactions). This success was clearly driven by stronger Internet distribution channels. As of now, Three Squirrels has over 200 SKU. Going forward, we trust in the company’s ability to introduce new products, diversifying their portfolio with creative, fun, and innovative snacks. It is prudent to say that the existing brand will bring consumers to other food categories at lower customer acquisition costs, resulting in a positive margin impact. Investment risks Food safety issues caused by excessive reliance on OEM and insufficient quality control Three Squirrels have entered the IPO listing queue three times so far but unexpectedly suspended the process twice, likely due to its violation of food safety standards. According to company prospectus, 7 consumers sued Three Squirrels for discovering worms in its dried fruit products. The National Quality Inspection Department also found that several nuts products showed excessive fungus. Such incidents were likely caused by the large reliance on OEM production, a model allows Three Squirrels to meet surging production demands but raises concerns on food quality. In the event that Three Squirrels fail to inspect those issues or fail to maintain food quality during the manufacturing, storage and transportation process, the company may experience both headwinds on financials and a further delay in IPO. Slower-than-expected growth due to intense competition and commoditized products As mentioned before, Three Squirrels saw its revenue significantly slowed down in 2017 due to shifting in channel preference toward offline, before posting a strong rebound in 2017. Although the current omnichannel business model makes it more competitive in the market, fierce competition remains a source of risk as competitors such as Be & Cheery, BESTORE and Daliyuan are aggressively leveraging both online and offline channels to take on a greater market share. Given that the types of products and pricing are very similar across these brands, future growth will mainly come from channels and brand effects. TAM and competitive landscape The relatively mature and stable snack industry was estimated at CNY 485 billion (USD 72 billion) in 2017, with a CAGR of 6% in the past 6 years, according to Guohai Securities. Benefiting from the secular growth of e-commerce, snack sales have partially shifted from offline mom-and-pop shops and retail stores to online venues. The online penetration grew to 11% in 2017. Assuming the online penetration of snack sales will grow at the current pace, reaching 15% by 2022, the online addressable market for Three Squirrels is approximately CNY 93 billion (USD 14 billion). According to Sealand Securities, the CR3 of the Chinese online snack sector was 23% in 2018. The three leaders were Three Squirrels, Be & Cherry and BESTORE, with respective market shares of 11%, 7% and 5%. While snack industry has a low barrier to enter, the sector leaders are benefited from scale advantages, which allow them to develop additional barriers (for instance, allocating more capital on marketing, developing more distribution channels, increasing warehouses and logistic centers, etc) Financial outlook Top-line: Revenue grew at 121% and 116% in 2016 and 2015, respectively. We expect the top-line momentum to be driven by new snack offerings and offline expansion. Risks come from potential pricing pressure, as we do not see meaningful differentiation across Three Squirrels, Be & Cherry and BESTORE from a product perspective. Gross margin: Most companies in this sector are running low margins (under 50%). COGS has declined significantly from 76% of total sales in 2014 to 70% in 2016, driven by higher ASP and lower material costs from suppliers. As a result, gross margin has been improving at ~300bps per year from 2014 to 2016. We see GM to continue to expand mainly due to the economy of scale and the addition of higher-margin products. We believe the 35~40% gross margin, comparable to the industry average, is achievable in the long-term. Sales & Marketing: The largest operating expenses come from Sales & Marketing which took 21% of total revenue in 2016. The number was slightly lower than the industry average of 23% and has been declined by ~400bps in 2 years, driven by lower logistics fees, marketing expenses, platform service fees and employee salaries as % of the total revenue. We see the S&M/Revenue to continue to drift lower as the top-line builds scale. Valuation based on comparable public companies: With similar business models and financial profiles, we believe Hao Xiang Ni (the parent company of Be & Cheery), Toly Food and Qiaqia Food are comparable companies. Based on the average FY18 P/S of 3.2x and average FY19 P/E of 2.7x forecasted by major brokers, we believe Three Squirrels could be worth around CNY 30 billion or USD 4.5 billion given its estimated FY18 sales of USD 1.5 billion. Business overview Products: Capturing the growing trend among Chinese consumers of consuming nutritious and healthy snacks, Three Squirrels mainly offers the following items: Nuts: pistachios, Hawaiian nuts, Badam nuts, pine nuts, almonds, pecans, peanuts, etc.; Desserts: bread, small cakes, cookies, popcorns, chocolates, etc.; Dried fruit: dried mango, dried strawberry, dried durian, dates, raisins, etc.; Meat: beef sticks, pork chops, etc.; Drinks: coffee with nuts, herbal tea, etc. Supply chain: Nuts are either sourced domestically or imported from the U.S., Brazil and Australia. They are then processed in China and other Asian countries and sent to one of three logistics centers in Beijing, Wuhu or Guangzhou (a new logistics facility in Chengdu is currently under construction). Freshness is one of the most important factors in food, and Three Squirrels relies on technology and information system to keep the products fresh. As an added measure, they also deliver products to customers within 60 days of being produced. Online channels: 1) ~70% of sales come from DTC channels, including Three Squirrels flagship stores on Tmall and JD.com in addition to Three Squirrels mobile app. 2) ~25% of sales come from third-party online distribution. The company partners with the primary Chinese e-commerce platforms including Tmall, JD.com, Suning.com, No.1 Mall and Dangdang.com. These platforms purchase Three Squirrels products and in turn distribute them to end consumers. Offline channels: 1) Self-operated stores: There are 45 self-operated stores called “Three Squirrels Feeding Store” and the number is expected to rise to 150 by the end of 2019. The entire store looks like a forest; pine trees and small squirrels are integrated into every corner. Other than selling snacks, the stores also sell products that are not available on the Internet, including phone cases, school bags and pillows with the squirrel logos. 2) Franchise stores: Franchise stores are expected to reach 10,000 in 5 years (open 5 stores per day on average). In order to maximize the franchise stores, Three Squirrels does not charge franchise fees or management fees and removes 90% of rules. Shop owners will have the freedom to personalize franchise stores based on their own preferences, in addition to designing exclusive promotional activities. 3) Partnership with Suning and Alibaba offline stores: Three Squirrels also collaborate with Alibaba and Suning to have the snacks sold in their physical stores. Doing so can not only fasten Three Squirrel's offline expansion process, but also allow it to take advantage of these tech giants’ logistic systems and broad customer base. *Please note that all data was sourced from Three Squirrel's prospectus unless otherwise stated.

Analysis EO
Analysis · 2
Analysis EO
Jan 21, 2019 10:51 am ·

Chinese New Year is Coming, Is BESTORE’s Gift Pack Big Enough For Competition?

Sent its IPO Prospectus Paper in 2018; employing the expensive hot faces, such as Dilreba Dilmurat (迪丽热巴) and Kris Wu (吴亦凡) to promote its high-end snack products prior to the Chinese New Year Festival Shopping Season; Spending large sums in packaging design. It seems BESTORE (良品铺子) is making all possible efforts in readying itself for IPO this year. The Chinese New Year is looming ahead, all snack companies had prepared their best shots, a variety of gift packs. Is BESTORE's preparation good enough for the New Year Shopping frenzy? Comparison between the Top 3 In Chinese New Year Festival Season EqualOcean made a comprehensive comparison between the top three brands in the industry, presented as follows: First, a comparison of the price of the nut snack per kilogram offered by the three brands: Three Squirrels, Bai Cao Wei, and BESTORE. The nut snack being a bundle consists of several different types of common nuts, such as pecans, almonds, walnuts, hazelnuts and so on. Collecting the pricing information from flagship shops of the three brands on JD.com (京东), Nut bundle from Three Squirrels (三只松鼠) costs an average of USD 12.22 per kilo, Bai Cao Wei (百草味) costs around USD 9.71 per kilo, while BESTORE, possibly due to its high packaging cost, ranked the highest, USD 28.55 per kilo. The expensive nut gift pack for the Chinese New Year is perhaps well affordable to Chinese families these days; but it does not mean ordinary Chinese people would fancy the idea of buying something exactly the same at three times of the original price, getting some colorful but useless packaging paper wastes afterwards. In order to look a bit more common people friendly and less like a greedy businessman, the brand could experiment the high price strategy in this special period, and if it did not go well, maybe lower the price level and quit from the experiment later. Two brands of the top three had employed celebrities to promote their products for this special time in China: Bai Cao Wei invited the Chinese teenage star Jackson Yee from the popular teenage boy band TFBoys, the aim is very obvious, to attract attention from the younger generations, after all, the major consumer group of the snacks had always been them. While BESTORE also spent a large sum on this, hiring two popular adult stars, Dilreba Dilmurat, a Uygur origin Chinese actress, and Kris Wu, a Chinese Canadian singer and actor; they are clearly trying to win the modern and young Chinese populations in this season. However, the Three Squirrels in this case, still believes the charm of its cartoon figures, not searching any help from the Chinese celebrities. Whether the squirrels are cute enough to support the brand to crown the New Year Shopping hysteria or not, only time will tell. All three had special gift set design for the special period: Three squirrels, still presenting the squirrels in 4 different color based common cubic boxes, as always, cuteness makes enough splash for them. Bai Cao Wei, on the other hand, features traditional and classic Chinese Lunar New Year style, which includes a series of shades of red, Chinese fan, the image of the big dinner on Chinese New Year’s Eve, and sceneries of Chinese people playing with firecrackers. The brand offers 9 options, which are the carefully selected, various combinations of different nuts. While BESTORE, though the design lacks the traditional Chinese New Year atmosphere, it offers a fresh image of the modern and fancy New China, with a touch of western, or international flare. In product innovation, Three Squirrels performed quite ordinarily again with almost nothing creative to offer except a drink combining milk, coffee and nut powder called The Second Brain (第二大脑) released a few days ago and yogurt bars. The interesting fact is the drink was obviously designed for young people, but if children's diet involves a large amount of caffeine, it could cause detrimental effects on their brain development. Bai Cao Wei, on the other hand, considers a lot for its customers, offering healthy and innovative snacks, such as freeze-dried vegetable and fruit without coloring and additives, and "one bite fruit juice", which is a bite-size, 100 grams soft cube formed by about 800 grams of fresh fruits, also no additives included. Needless to say, this is definitely the new trend in FMCG industry in China now and the future: Green, fresh, no additives, healthy and tasty. BESTORE, offers products quite similar to Bai Cao Wei, but not as innovative and thoughtful yet. It has many options of freeze-dried vegetables and fruits, Lou mei snack like the other brands offer, it also has the yogurt bar as Three Squirrels, but not enough innovative and healthy snacks to offer. What's worthwhile to be mentioned is, BESTORE, offered a very rare type of New Year Gift Set, the Duck Parts New Year Gift Set, which stands out in the crowd of New Year Nut Gift Packs offered by other brands. This may register success in this season because it is the only brand eyes on the Chinese's weird tongue for animal parts. The pack includes duck tongue, duck wings, duck foot, duck offal and the like, all are Lou mei snacks. Revenue Growth Rate Decreases According to the IPO Prospectus paper sent by BESTORE, the company's revenue is increasing year on year, but the growth rate is declining for the past three years. EqualOcean calculated the numbers and presented it in the format of a bar and line chart as follows: According to the chart, the company's revenue growth rate in 2016 was 36.20%, above the industry average of 20%, decreased to 11.92% in 2018 (data only includes the first half year's revenue, the 2018 yearly revenue is estimated based on this), showing a quite significantly slow down. Its competitors, to the opposite, had not experienced a similar trend. For example, Bai Cao Wei, has remained its whopping 40% growth rate in the first half year of 2018, claiming to have more than 55,000,000 consumers; Three Squirrels claims to have about 70,000,000 consumers as well. Bai Cao Wei even achieved its goal of earning profits in the low season of snack purchasing in China, Q2 of 2018, which was a big success compared to its usual revenue deficit in the same period in previous years. Nevertheless, BESTORE still enjoys an optimistic environment in China, where the industry average growth rate exceeds 20%. By estimation, the market size will grow into a scale of CNY 2,000,000 million (USD 294,610 million) by 2020, thanks to hundreds of thousands of snack producers in China. Also, the technology barrier of snack producing business is quite low, comparing to the other industries. Hence competition can be furious, but this also brings benefits to the companies which cannot rank the top; since the top companies cannot dominate the market, all brands, regardless of the size and product quality, they can always find customers in the market and survive. The flourishing of the snack industry is arguably good news for BESTORE, if the company made wise moves and it might have the chances of crowning. High-End Snack, Ineffective Market Positioning? A snack is a small serving of food and generally eaten between meals. It had always been pictured as something down to earth, even the content of British royal afternoon tea closely resembles the afternoon tea offered in common tea houses. When the snack brand picture itself as a high-end indulgence, it is separating itself from the general public. The essence of high-end snack should lie in the quality of the snack, not excessive packaging. The high-end product positioning of BESTORE comes with extravagant packaging, which contributes a large portion of the cost, therefore, the price of the snacks are set pretty high to cover the costs. As temporary marketing methods, the positioning might yield benefits; They will fail to aid with the sales of the brand in the long term. Brick and Mortar Store, the opportunity to win? Though BESTORE has launched the very first brick and mortar shop as early as 2006, their shops had never gained enough attention, snuggling in unattended corners lack of touch from the public. There are only 4 shops within the Beijing fourth Ring Road after 13 years. Comparing to its peers, the brick and mortar shop should be its paramount competitive edge, since the others are mainly focusing on online sales. But arguably, BESTORE had wasted the abundant opportunities generated from its physical stores due to wrong locationing strategy and possibly not effective enough management of its retail outlets. The top two brands in China snacking industry, Bai Cao Wei and Three Squirrels, had always been neglecting its brick and mortar shop sales. The reason behind this is probably they had found out that, customers usually randomly choose one snack pack on an online store, such as JD.com, Tmall, and Pinduoduo, then if after consumption, the taste or general experience was not satisfying, they will quickly opt for another brand online, until they find the best among them all and settle. Also, the cost for these trial and error is not excessive because the unit price for snacks from any brand is not significantly differentiated from each other, and in most occasions, capped at a fairly low level. The trial and error period cannot last too long either since the customer might as well buy a few packs from different brands and have a tasting test of them all in one purchasing. Hence the online sales are probably sufficient enough, further marketing efforts or opening of brick and mortar stores are not urgently needed for expanding sales. In order to stand out, BESTORE really should choose eye-catching locations with heavy customer flow on high streets, such as Xidan Joy City Area, The Place (Shimao Tianjie) and Taikoo Li Sanlitun shopping arcade in Beijing and the like. Exaggerating decorations and sense of romance and cuteness could successfully attract young couples, children and teenagers, who are the main consumers of nuts and snacks, and have the tendency of impulse purchasing in China. Apart from generating more sales, the newly opened physical stores could further help the company to promote its brand image to the public, this will surely lead to revenue surge later.