Auntea Jenny brews up bigger profits with focus on smaller cities

The operator of bubble tea franchises has accelerated its expansion into urban areas beyond China’s main cities, driving a 42% jump in first-half revenue

Key Takeaways:

• Auntea Jenny added nearly 1,700 outlets on a net basis in the first half, with the store count in third- and lower-tier cities growing nearly 46%
• Core margins held steady and the next test will be whether the store ramp-up can deliver a greater profit boost

By Lee Shih Ta

For China’s milk tea chains, reaching the milestone of 10,000 outlets used to be seen as clear proof of expansion potential. But store count alone is no longer enough to assure investors about future growth.

As a host of beverage chains have converged on the Hong Kong equity market, among them Mixue Group (2097.HK), Guming (1364.HK) and Chabaidao (2555.HK), so performance expectations have risen, and tea brands need to show where their next phase of growth will come from.

For many, that means turning their focus from the largely saturated markets of major Chinese cities to the smaller urban centers where rents and operating costs are lower. One chain competing in that battleground, Auntea Jenny (Shanghai) Industrial Co. Ltd. (2589.HK), accelerated its rollout in third- and lower-tier cities in the first half of this year, according to its latest earnings report.

Auntea Jenny serves up milk teas and fresh fruit beverages with a mid-priced business model. Its franchised store count jumped nearly 1,700 on a net basis in the first half, helping to lift revenue 42.4% to 2.59 billion yuan ($384 million), while profit for the period grew 58.3% to 321 million yuan. Adjusted profit for the six months rose 41.6% to 345 million yuan from the year-earlier period, broadly in line with revenue growth, while the adjusted profit margin remained at around 13.3%.

Net profits enjoyed an extra lift, outpacing revenue, as the year-earlier period included expenses related to its listing that were absent this time. Share-based payment costs also declined and the effective tax rate fell to 22.7% from 27.6%. The company’s gross profit margin remained at around 31.6%, while administrative expenses edged up 2.3%, suggesting that some back-office costs were spread over a larger revenue base. But spending on sales and marketing jumped 56.1%, with expenses for marketing and promotion nearly doubling, offsetting some of the benefits of scale.

Doubling down in smaller cities

The standout feature was a rapid expansion of the franchise network in lower-tier markets. The firm opened 2,253 franchised stores in the first half, up 149% from a year earlier, while closures fell 13.8% to 556. That resulted in 1,697 net additions, more than six times the year-earlier figure. By the end of June, the company had 13,155 stores under its brand, a year-on-year rise of 39.4%.

In third- and lower-tier cities the store count rose 45.6% to 7,022, taking the share of the total to 53.4% from 51.1%. With its mid-priced strategy, Auntea Jenny is focusing on expanding its footprint in lower cost markets, swerving the cut-throat competition for tea drinkers in China’s biggest cities.

The net jump in outlets suggests that the franchise model is enjoying growing appeal, as the company welcomed 1,625 franchisees during the period, more than double the year-earlier number.

Auntea Jenny makes most of its money from selling ingredients, packaging and equipment to franchisees. Income from sales of goods to franchisees rose 41.6% to 2.08 billion yuan in the first half and, together with related services, accounted for more than 95% of turnover. With revenues and stores growing in tandem, the new franchises look to be the company’s main growth driver.

Pursuing economies of scale

However, the momentum has not flowed through to core profit margin, which edged up to 31.6% in the first half from 31.4%, while the adjusted margin slipped to 13.33% from 13.40%. Administrative expenses as a percentage of revenue fell to 3.7% from 5.1%, indicating that those costs are starting to be spread over a larger revenue base. But selling and marketing expenses rose to 11.3% of revenue from 10.3%, offsetting most of the benefits.

As the network expands, the company’s ability to achieve economies of scale while keeping a lid on marketing expenses will determine whether store growth can translate into better margins.

Cash generated from operating activities rose 28.7% to 287 million yuan, lagging overall earnings growth but still equivalent to around 90% of profit for the period. As of the end of June, the company held 1.40 billion yuan in cash and bank deposits and had just 18.6 million yuan in bank borrowings, giving it a substantial buffer for continued expansion and investment in its supply chain.

Auntea Jenny’s shares jumped 10% in the first session after the earnings release, as investors welcomed the figures. The stock has gained about 34% in the year to date to trade at HK$113.90, slightly above its HK$113.12 offer price in May last year. Auntea Jenny trades at about 16.7 times annual earnings, below Guming’s 18.5 times but above the 12.3 multiple for Mixue Group.

Auntea Jenny has shown that its franchise model can be popular in smaller urban centers that still have room to accommodate further outlets. As its store count in those locations surpasses 7,000, investors will increasingly focus on whether the pace and quality of expansion can be sustained, and whether the scale can translate into higher margins and stronger cash flow. If the company can deliver on those fronts, its valuation could still have some room to rise.

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