The Company’s 1H25 revenue/NP dropped 18.5/29% YoY, in line with the profit warning. The weakness was attributable to a 23% YoY decline in the water biz (hit by weak demand, fierce competition and channel reform) and moderated beverage growth (+21% YoY) driven by volume growth but price decline. We expect full-year revenue decline to narrow given low 2H24 base and positive sales in Jul-Aug. Capacity expansion proceeds as planned, while positive impacts are muted by sales pressure. Since in-depth channel reform is ongoing which is expected to be completed by 2026, we anticipate the combined benefits of both to materialize in FY26 or beyond. We cut our TP by 41% to HK$12.85 to reflect earnings pressure. The new TP implies 18x 2026E P/E, as we believe 2026 will be the year when the impacts of reform gradually ease and its business shifts to steady-state operation. Meanwhile, as a central SOE, the Company’s business plan will be incorporated into the Five-Year Plan, and it is reasonable to clear earnings drags before the new phase, in our view. Maintain BUY.
　　Water biz under ST pressure, Beverage biz growth moderates. Water biz revenue declined 23% YoY to RMB 5,251mn in 1H25, with small- sized/medium-to-large sized /barreled water down 26.2%/19.4%/1.5% YoY respectively, due to weak demand, fierce competition and the company’s channel reform. Beverage grew 21% YoY to RMB955mn (vs. 40%/31% in 1H24/FY24) as promotion spending weighed on ASP even though 14 new SKUs were launched in 1H25. Looking into 2H25: 1) the Company noted water biz decline has narrowed since peak season, with both water and beverage posting positive YoY growth in Jul-Aug; 2) late launches (Jun-Jul) of competitive beverages may deliver positive impacts in 2H; 3) low 2H24 base. We expect water rev. decline to narrow and beverage rev. growth to expand slightly in FY25.
　　Capacity expansion on track, payback period may extend. The Company is executing its capacity expansion plan as scheduled: Wuyishan large-size production line commenced operations in 1H25, with two factories to come online in 2H25. The 2025 target of 60% self-owned capacity remains unchanged. We previously calculated that a 10% higher self-owned capacity ratio could drive a 1.5-2ppt GP margin improvement (report), but this benefit was muted by soft sales in 1H25. We believe that as consumption sentiment recovers and capacity expansion is implemented on track, positive impacts will gradually emerge over a longer horizon.
　　Channel reform weighs on ST earnings, benefits to emerge post FY26. The Company has launched in-depth channel reforms, including: 1) flattening distribution channels in tier-1 cities from 4 to 3 levels; 2) adding over 100 distributors dedicated for beverage products; 3) setting specialized distributors for e-commerce, careering, and emerging channels; and 4) dedicated distributors for lower-tier markets (counties/towns/villages). These initiatives, scheduled for completion by FY26, will deliver compounded benefits alongside ongoing capacity expansion, in our view.
　　Maintain Buy. We slash our TP by 41% to HK$12.85 to reflect earnings pressure. The new TP is equivalent to 18x 2026E P/E, as we view 2026 as the year when the company’s reform impacts gradually ease with operation shifting from transformation stage to a steady state. Risks: 1) greater-than- expected economic downturn; 2) slower-than-planned capacity expansion; 3) underwhelming channel reform results; 4) food safety incidents; 5) raw material price hikes, etc.