A leading teahouse operator in China well positioned for market share gain; Initiate with BUY
　　Leaving the booming growth phase behind, we believe China’s freshly- made tea market should enter into the trajectory of rising concentration rate. We expect leading players’ competitive advantages to gradually emerge and underpin their profitability enhancement. We initiate BUY on Nayuki with TP of HK$5.3, seeing its undemanding valuation currently. Given its leading position in China’s freshly-made tea market, we believe its continuous efforts in scale expansion, brand building and innovations would facilitate its market share gain in future.
　　Key Factors for Rating
　　A leading teahouse operator in China well positioned for market share gain. We expect the concentration rate of the top players in China’s freshly-made tea market to rise despite normalised market growth, as leading players are better positioned to accelerate their growth, backed by strong knowhow in the business, strengthened back-end infrastructure, strong cash position and fundraising capability. We reckon scale is the major competition moat in the industry. We believe Nayuki’s dual engine of self-operated model (in higher tier cities) and franchise model (for penetration in lower tier cities) would underpin its accelerated network expansion, for market share gain in China’s freshly-made tea market.
　　Steady growth in single store sales from 2024 onwards. Average daily sales of Nayuki teahouses declined in the past few years due to various headwinds (e.g. the pandemic) as well as its proactive store format adjustment. Recovery of average daily sales remained bumpy in 2023 given the gloomy economy. Yet, we remain positive on steady average daily sales growth in the long term on the back of ticket size increase (on product mix optimisation) and stable order demand. With the development of off-premise business, thoughtful site selection, enhanced brand equity, product innovation and improved values for consumer, we expect Nayuki teahouses to secure stable order demands, the backbone of the business. On top of that, we expect ticket size to trend up in coming years on product mix trade-up, despite short-term hiccups given recent weak consumer sentiment and competition. We expect Nayuki to stay committed to product innovation, underpinned by strengthened supply chain capability.
　　Potentials in profitability enhancement on optimised unit economies. The long lasting pandemic urged the company to adjust its store format and optimise cost structure at its teahouses for margin enhancement, the benefits of which would be further released when store sales normalise on fading pandemic disruption. We expect GP margin for self-operated stores to expand gradually on the back of strengthened supply chain and improved accuracy of marketing activities. More notably, the company is able to simplify the layout of its Nayuki teahouses and in-store operations, with enhanced labour productivities, advanced digitalisation and upgraded store format (i.e. PRO format). We believe the company’s profitability will further improve, given rising economies of scale, improved competition landscape and macro environment.
　　Key Risks for Rating
(1) continuous weak consumer sentiment and economy (2) intensified competition (3) slower-than-expected store network expansion (4) food safety issue and (5) unsuccessful execution of franchise model.
　　Valuation
We expect EPS to turn around to RMB0.067 in 2023, from a loss of RMB0.269 per share in 2022. We anticipate EPS growth of 274/84% YoY in 2024/25E to RMB0.249/0.459. We derived our TP of HK$5.3, based on 20x 2024E P/E, in line with Starbucks, as well as leading restaurant operators such as Yum China.
　　Investment Summary