Three stages of development in China staples food sector: 'branded' has quality growth

Our review of the history of the food sector reveals China's food industry generally undergoes three stages: bulk food, packaged food, and branded food. During the 'bulk' to 'packaged' transition, the industry witnesses increasing sales volume while facing fast-changing competitive conditions, heavy capital input and slow improvement in profitability. Going further toward the 'branded' stage, the industry shows rising ASP, stable competition, solid free cash flow and expanding margins. We think firms in the 'branded' stage provide more long-term value.

Food demand was traditionally met on a local, fragmented basis in the last century. In 2000, the food industry generally entered the 'packaged' stage, as related infrastructure improved, industrialisation progressed, and logistics networks allowed food firms to expand sales nationwide. Since 2010, some subsectors have phased into 'branded' amid upgrading consumer demand and flattening communication channels. Based on our quantitative analysis of packaging adoption and brand premium, we believe fresh pork and 2C (to customer) ready meals are in 'bulk' to 'packaged ' transition, while the dairy, condiment and pickle subsectors are migrating beyond 'packaged' to 'branded

Subsectors progressing to 'packaged' grow due to increasing convenience, as well as a higher packaging rate that drives more packaged food. In this phase, which is marked by instability due to price competition and channel acquisition, consumers are mainly interested in convenience and price. Margins are kept down by fierce competition and hampered ASPs, reflecting homogeneous products. Subsectors moving to 'branded' see consumer demand turning to brands and differentiated offerings, with price replacing volume as the revenue driver. Brand power and innovation capability raise barriers for competitors, leading to relatively stable industry conditions and higher margins. Firms in the latter phase provide more long-term value, in our view.