In uncertain times, Nayuki bets on enduring consumer taste for premium tea

The leading maker of milk tea aims to boost its store network by 40% in the second half of this year, taking advantage of favorable rents and locations in China’s depressed retail market

Key Takeaways:

• Nayuki plans to open 474 new stores in the second half of this year, a major boost from its total of 1,194 stores at the end of June
• The company recorded lower spending per order in the second quarter compared with the first, reflecting growing consumer caution

By Doug Young

It’s tea time!

That’s the latest tune coming from premium tea chain operator Nayuki Holdings Ltd. (2150.HK), which is seizing on a depressed retail market to ramp up an expansion that will boost its store count by 40% in the second half of the year, according to a second-quarter business update released by the company last Friday. This particular trend isn’t really specific to Nayuki, but instead reflects a broader movement among many big restaurant chains in China these days.

The bigger backstory to this expansionary tale is the huge blow Chinese retailers suffered during the pandemic, culminating in mass store closures last year as local governments tried to stop the spread of the highly contagious Covid-19 Omicon variant. Many smaller retailers lacked the resources to weather such harsh measures, and ultimately closed as a result.

Those closures have led to higher vacancy rates and lower rents in many of the most popular shopping malls and other locations where companies like Nayuki, KFC, McDonald’s (MCD.US) and Starbucks (SBUX.US) typically like to set up new shops. As a result, many of those chains kept opening stores at a brisk pace last year, despite all the restrictions, and are now even accelerating those expansions to take advantage of desirable space and cheap rents.

Nayuki first disclosed its plan to accelerate its new store openings in April, announcing it had boosted its target to 600 new outlets for 2023. “In January and February 2023, the company experienced much less difficulty in identifying locations for opening new Nayuki teahouses,” it said in its first-quarter update at that time. “The company was able to acquire a better location at a reasonable price.”

While Nayuki has big plans for the full year, its new second-quarter update showed it added a relatively modest 88 stores in the second quarter, bring its total store count to 1,194 and its net additions in the first half of the year to just 126. That means the company would need to open another 474 stores in the second half of the year, equal to our previously mentioned 40% increase in its store count, to meet the 600-store target.

The ramp-up comes as Nayuki shows signs of a relatively strong rebound from the pandemic, even as China’s broader retailing picture remains cloudy. On the one hand, weak recent sales for big-ticket items like cars, smartphones and real estate seem to reflect consumer caution about major spending due to signs of rapid slowing in the Chinese economy. But spending on smaller, cheaper items like milk tea seems less affected, and many people may even be splurging more on such little luxuries as they forgo more costly items.

Nayuki alluded to the more cautious consumer sentiment in its latest update, noting that the size of an average order decreased during the period compared with the previous quarter. It noted its average price for new products was relatively lower in the second quarter compared with the first, which, again, seems to reflect an increasingly frugal attitude among consumers.

Investor caution

If Nayuki’s latest report reflects the cautious mood among Chinese consumers, the company’s stock price seems to reflect similar caution among investors. Nayuki’s stock actually fell 2.6% in Monday trading, the first day after the release of the second-quarter update. The stock is down 29% so far this year, which is probably more reflective of concerns about the Chinese economy than individual issues with Nayuki.

Investors could also be slightly concerned about the implications of such a rapid build-up if China’s economy continues to weaken. That’s because consumer caution tends to cascade down the food chain, so to speak. Today consumers are avoiding the most expensive items like cars and smartphones. But if the weakness continues, many may start to rein in spending on things like eating out and other nice-to-have-but-not-necessary items like milk tea.

If that happened, Nayuki could be left with a majorly expanded store network but not enough business to make those stores profitable.

The company has yet to turn a profit since 2019, the first year for which its financial data is available. But the 15 analysts polled by Yahoo Finance all expect it to post its first-ever annual profit this year on strong revenue growth of about 70%, fueled by rebounding demand and the store expansion. That would mark a huge improvement from last year, when Nayuki’s revenue was flat at about 4.29 billion yuan ($601 million), and it posted a 461 million yuan adjusted net loss.

Based on analysts’ profit predictions for this year, Nayuki actually has a relatively strong forward price-to-earnings (P/E) ratio of 28, which is slightly ahead of the 25 for both domestic rival Xiangpiaopiao (603711.SH) and global giant Starbucks (SBUX.US).

That seems to indicate that investors are relatively upbeat on the company despite its weak stock performance this year. One reason for that confidence could lie in Nayuki’s potential to become a consolidator in China’s fragmented and highly competitive market for premium coffee and tea. The company took a step in that direction last month when it completed its purchase of 44% of rival Lelecha for $75 million – a deal first announced last December.

As a public company, Nayuki also enjoys access to Hong Kong’s capital market that larger rival Heytea currently lacks. Many expect Heytea to also make an IPO, and reports in 2021 said the company had even hired investment banks for a listing to raise up to $500 million. But no deal ever followed, and it seems unlikely that Heytea will list this year due to the dismal demand for new listings right now.

At the end of the day, Nakuyi’s aggressive expansion looks quite opportunistic and could boost its chances of emerging as one of a handful of major players in China’s premium tea market. The big wild card is China’s economy, which could leave the company saddled with a huge network of underperforming stores if consumer sentiment continues to weaken and people decide a premium milk tea is one luxury they can live without.

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