Nayuki tweaks franchising model as competitors serve up rival listings

The premium tea seller had 205 franchised stores in its network at the end of March, following its decision last year to diversify beyond self-operated stores

Key Takeaways:

• Nayuki’s new store openings slowed in the first quarter due to seasonal factors, as it tweaked its franchising model aimed at boosting its presence in smaller cities
• The premium tea seller will soon face new competition for investor dollars in Hong Kong, as at least five major rivals have filed for IPOs since last October

By Doug Young

Apart from fresh data showing a sharp slowdown in its store count growth and a slow start for its franchising business, the latest quarterly update from premium tea chain Nayuki Holdings Ltd. (2150.HK) is notable for one thing that’s not included in the Thursday filing. That unspoken fact is that this will be the last time Nayuki issues such a report as the lone Hong Kong-listed company from China’s crowded premium tea sector, also often referred to as bubble tea for one of its best-known products.

At least five other premium tea chains have filed to list in Hong Kong since last October, including industry leader Mixue, which filed for its IPO in January. Of those, only Sichuan Baicha Baidao (2555.HK), also known as Chabaidao, has been approved and officially launched its offering last week, underwritten by local powerhouse CICC as well as Citigroup.

The Chabaidao listing offers the first real valuation comparison to Nayuki, which has had the luxury of being the only choice from the bubble tea sector for investors since its listing in 2021. With all these new listings now coming to market, most of them much bigger in terms of store count, Nayuki will face far more competition to attract investor attention and will have to work extra hard to keep them interested in its story.

Nayuki and many of its peers suffered quite a bit during the pandemic since many of their stores were closed or faced other limits to their operations as part of China’s strict Covid controls. What’s more, their premium teas are mostly a “feel good” type of product that people often buy when engaged in the type of socializing that was quite limited during the pandemic.

As a result, Nayuki and many of its peers lost money during the pandemic and only returned to profitability last year with the lifting of restrictions. Accordingly, it’s more useful to look at their price-to-sales (P/S) ratios when making comparisons to see who investors like, rather than the usual price-to-earnings (P/E) comparisons.

In that regard, Nayuki has P/S ratio of just 0.72, which looks quite low when one considers that any growth company should generally be valued above 1, and often much higher. Chabaidao’s IPO launch document filed last week revealed it will have a market cap of about HK$26 billion ($3.3 billion) based on its IPO price of HK$17.50 per share. That would give it a P/S ratio of 1.4, or roughly double Nayuki, based on its 16.9 billion yuan ($2.33 billion) in revenue last year.

But Chabaidao’s ratio is hardly anything to get too excited about either when compared with similar coffee chain operators. Shares of local coffee sensation Luckin (LKNCY.US) and Starbucks (SBUX.US), which counts China as its second largest market, both trade higher with P/S ratios of 2.1 and 2.7, respectively.

The key takeaway in this regard is that investors are quite wary about this new group of premium tea makers now coming to market due to the stiff competition that’s likely to force some out of business in the years ahead. That means we’ll probably see a healthy dose of pressure on the stocks as they flow onto the market in the next year or two.

Slow growth

All that said, we’ll return to the latest quarterly update that shows Nayuki’s new store openings slowed considerably in the first quarter, which is typically slow due to cold weather that tends to discourage consumption. The company opened a net 23 new self-operated stores during the quarter, bringing its total to 1,597 by the end of March. The latest figure was sharply slower than 214 new stores openings in the fourth quarter, and 166 in the third.

But we should also note that the latest store count was up more than 70% from the company’s 923 self-operated stores at the end of March 2023.

Nayuki also revealed for the first time that it had an additional 205 franchised stores in its network at the end of March, following its strategic decision last year to enter the franchising business. Still, the company’s total of about 1,800 self-operated and franchised stores is far behind Chabaidao’s nearly 8,000 stores at the end of last September, and is light years behind Mixue’s industry-leading 36,000 stores at that time. Nearly all of Chabaidao’s and Mixue’s stores are franchised.

Nayuki also gave some of its first detailed discussion about progress for its franchising initiative, which is aimed at helping it expand into China’s smaller third- and fourth-tier cities. That discussion appeared to show the company is still experimenting with the business model before attempting a more aggressive expansion that could help it to catch up with its larger rivals.

“We optimized the requirements for franchisees in February 2024, as a result, the store model became more flexible, the requirements for areas have been lowered and the investment amount for single store also decreased to 580,000 yuan. These will help reduce capital pressure of franchisees and facilitate the continuous growth of the franchise business,” it said.

Investors weren’t too impressed with the latest report, bidding down Nayuki’s shares by 3.8% in early Friday trade in Hong Kong. At that level, the stock is now down about 30% so far this year and is down 90% from its IPO price in 2021, reflecting the investor skepticism that we previously mentioned.

The franchising business will inevitably bring new issues for Nayuki, most notably due to quality control and margin pressure. The company’s gross margin currently stands at about 40%, compared to 34% for Chabaidao, and about 31% for Auntea Jenny and Guming, two other large bubble tea chains that have filed to list in Hong Kong.

At the end of the day, investors probably won’t be too excited about Nayuki’s stock over the near- to medium-term due to all the new rivals coming to the Hong Kong Stock Exchange. But it could still potentially prove attractive over the longer haul if it can rapidly expand its franchising business without sacrificing its margins too much.

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