Nongfu Spring: Adverse Consumer Sentiment Dragged Bottled Water Sales; Retain Fair Value Estimate

We moderately lower our 2024 earnings forecasts for narrow-moat Nongfu Spring ahead of the release of its interim results, as we expect its drinking water sales to be affected by the negative controversy toward the brand during the first-half of this year. We think demand for other beverage segments should remain steady. We note that most of the accusations toward Nongfu Spring were not well grounded and were unrelated to product safety. As a result, we do not see a material threat to its long-term competitive advantage, and the sales headwind should be short-lived. We raise our 2024 selling expenses ratio to account for increased advertising and marketing spending to enhance near-term sales, which led to a 3% cut to our 2024 net income forecast. We also expect 2024 net margin to normalize to 25.9% from over 28% last year, which was boosted by doubling sales of the tea segment. However, we keep our longer-term earnings estimates largely unchanged, and we retain our fair value estimate at HKD 42.50 per share, which implies 34 times 2024 price/earnings, 20 times EV/EBITDA, and 2.2 times dividend yield. We think shares are currently fairly valued.