I transcribed the Q2 earnings call Q&A, as I found it insightful. There is also a transcript of the rest of the call on the IR page & webcast is available there as well.
*1 is at the very bottom
Summary:
This was a weak quarter & the outlook for the rest of the year is rather poor as well.
The main problem remains SSS (Same Store Sales), with -7% QoQ decline, which is an alarming 25.2% annualised, despite Q2 being seasonally stronger than Q1, although this can be mitigated to some degree by an issue that is temporary (*1).
At the same time core operations remain at solid profitability & at least some part of the currently poor performance is impacted by temporary headwinds, even though some problems are likely not temporary.
My long-term investment thesis remains intact, although somewhat bruised.
Nonetheless I still have conviction about the long-term potential & trajectory of the company.
I will therefore stay significantly invested, but am considering rotating partly into other stocks, as the outlook for at least the next two quarters is rather poor - likely similar to this quarter - and I still see some very interesting opportunities in the market that might perform better over the next 6-12 months. I currently hold ca. 13.5% of my stock portfolio in $CHA at a cost $ average of $23.84.
The bad:
The big problem continues to be the continuing SSS decline within the core market China (96% of revenue)
(From Q2 2024 to Q2 2025)
-SSS continue to decline YoY (-23%) and sequentially (-7%), despite Q2 historically being stronger quarter than Q1. (This particular quarter (Q2) is mitigated by a factor I explain below (*1))
-This is presumably related to increased economic insecurity & a weak consumer in China, leading to consumers buying lower price teas, such as Guming; this undermines Chagee’s focus on higher-cost mid-premium tea products
-also the new style tea market in China has slowed down significantly
-Chagee’s focus on building sustainable growth by avoiding price wars and focusing on high quality and brand value appears to be (at least currently) failing to some degree within China (where 96% of revenue comes from)
-This is despite management saying in Q1 earnings call that they would focus more on SSS in the future (although for a Chinese company that might not mean next quarter; Chagee in particular is focused on long-term strategy, not QoQ as I explain in my thesis (on Substack))
-Marketing expenses are already very high, so it’s unlikely that they can increase that for improved SSS
-CEO in earnings call was focused on overseas & not SSS in China, which I frankly don’t appreciate, as this a very reasonable concern for investors, as China is still over 96% of revenue
-Teehouse expansion in China is still ongoing, which is a questionable choice considering the declining SSS, regarding which self-cannibalization (ie. Stores competing with each other) no doubt plays a role, especially considering the focus on urban mid-premium costumers - low to mid price players, like Guming have more room for expansion into smaller cities and suburbs. But: this strategy is not without strategic rational
Teehouse expansion for greater China:
-3.53% QoQ Growth in Q1 -> 14.91% annualised - this shows that management quickly -moderated teehouse growth after the first YoY SSS decline in Q4 2024 & is aware of the issue
-Reaccelerated to 4.78% QoQ Growth in Q2 -> 20.51% annualised - this is a questionable choice imo, but not without rational as I will elaborate below
-Q1 QoQ teahouse growth did slow down a lot from the quarters before: 10.40% in Q4, 16% & 20% before that
-Note that YoY numbers can look misleading, as QoQ growth was much higher until Q4 2024
-high marketing & administrative expenses led to flat net income YoY (+0.2%), despite 10% revenue growth (this is sth I’m not concerned about at all rn as I will explain below)
-Due to company structure there is a lack of independent oversight & the power is completely concentrated around CEO Zhang Junjie; there are structural similarities with Luckin (note that this structure is common for Chinese companies & is not suspicious or anything on its own & there are currently no indications that anything shady is going on) - but trouble with financials could make fraudulent activities more likely - but the balance sheet is very strong, so there is little motive with regard to that
-As in Q1 no guidance was provided: “At this time, we will not be providing formal financial guidance for the whole year. Our priority is to execute our long-term growth strategies and deliver lasting value to our shareholders.” That does not scream confidence for the next 2 quarters
-while I was not optimistic about this quarter, the results were worse than I expected; I expected more of a boost from seasonality & even significantly increased my position in the week before earnings -> this raises questions about my reliability & understanding of the company & market environment and raises questions about the viability of my overall investment thesis → following other investors might be advisable
-Chagee mostly missed the global Matcha (Japanese tea drink) hype, while Heytea was quick to adopt it & thrived as a result, possibly taking market share from Chagee, although the exact effect is difficult to measure
-barely to no significant near-term catalysts ahead (that I can think of)
-The current headwinds will likely continue at least into Q3, as I further explain below (*1)
-while Zhang Junjie has been very successful in expanding teahouses so far - does he also know how & when to stop teehouse expansion (within China) & focus on SSS? Does he know how improve SSS in the difficult market environment?
Silver lining:
-although economic insecurity & the weak Chinese consumer could be a longer-term issue, there are also some headwinds that are temporary, specifically the delivery price war (*1), which started in February this year, impacting Q1, fully impacting Q2 & is going to impact Q3 as well. This peaked in July and has been somewhat easing since. (*1)
-Chagee stays at solid profitability with a stable net profit margin of 18.9% (adjusted)
-Gross margin reached 53.9% due to steadily improving operating costs, up from 48.4% YoY and sequentially from 53.1% in Q1 2025. This is what matters to me at the current expansion stage, not net income (up only 0.2% YoY).
-This trend will highly likely continue in the future with new tea machines coming into stores this year and plans for more operating cost control
-Importantly, the expanding teahouse network (within China) strengthens Chagee’s negotiating power, supply chain and operating costs which can also be passed on to consumers in the future while maintaining the same high quality - when (if) the current headwinds subside Chagee will have a stronger teahouse network than direct competitors, such as Heytea, enabling them to lower operating costs compared to the competition while maintaining the same quality
Management places very strong importance on market presence, so accepting temporarily lower SSS for stronger market presence in the longer-term visio has a reasonable rational and might give Chagee a competitive advantage against the direct competition long-term.
-Sales & Marketing as well as Administrative costs rose significantly, which I absolutely don’t mind for now considering the ongoing international expansion, which requires strong investments - and the very strong balance sheet and steady profitability of the business position Chagee very well for international expansion; what is important here is operating/gross margin, which is looking quite strong
-Balance sheet remains very strong: Chagee currently has about $1.24 billion in cash providing strong reserves to fund expansion; total net assets are $1.144 billion
-Valuation: At
- a market cap of $3.55 billion
$1.24 billion in cash, net assets at $1.144 billion
Pe ratio (using Q2’s eps of 0.46 annualised) of ca. 10.4
Chagee is now even cheaper than before earnings
-International expansion is progressing well, even though it’s still early (les than 4% of revenue); overseas expansion has recently started in the US, Indonesia, Philippines, Vietnam & is already ongoing in Malaysia, Singapore & Thailand; active plans are being made for Japan and SK
-international GMV increased 77.4% YoY & 31.8% QoQ, but this doesn’t yet impact overall top-line in any significant way
-as they have shown in the past within China and supported by their JVs in Malaysia, Thailand & Indonesia they can expand very fast once a base & understanding of the market is established - growth can be explosive, much quicker than with typical beverage chains
-Recruitment of strong management continues:
Emily Chang as CCO for North America, former CMO at Starbuck’s China
Aaron Harris as CMO for North America, Senior VP of Development at Dutch Bros Coffee
-CEO has history of good choices so far, although the SSS in China have so far not been successfully tackled. Nonetheless he is steadily focused on the long-term vision, which might be better in the long run. In the past for instance he expanded aggressively during Covid 19, when the competition was hesitating; this proved to be an excellent decision
-possible positive near-term catalysts (not good compared to negative ones):
*International expansion will accelerate from here on, including in the US, which might lead to more visibility and investor confidence
*positive insider purchase behaviour
-The current vision for overcoming current headwinds is - as I understand it - is the following: The weak Chinese consumer/economic insecurity and the delivery price wars and subsidies are not within Chagee’s control. Chagee therefore focuses on maintaining their high quality product and improving operating costs, which they can to some degree pass on to consumers. Maintaining and working on their product quality and brand will eventually convince the consumers to return to and choose Chagee, once the current delivery price war eases and consumer sentiment changes in Chagee’s favor. Management believes that over the long-term the Chinese consumer is evolving from cheap low-quality to more high-quality products, that might be a little bit more costly, as long as price is still reasonable. The very strong balance sheet and profitable core operations enable Chagee to pursue their long-term vision, especially international expansion, where they face an easier competitive environment.
This is a reasonable strategic plans. The main concerns that I have is that Chinese consumer sentiment might be unfavourable for Chagee over a longer-term period; as long as Luckin or Guming come close enough to Chagee’s product for a much cheaper price consumer might switch
What I look out for now:
-SSS in China will remain the most important problem by far and I want to see at least a stabilisation within the next 2-3 quarters
-for this the Chinese macroeconomic landscape & consumer preferences as well as competition are important, so I will be watching that as well
-International expansion will accelerate from here & I will be watching closely; this is very important for the long-term story, although it will only become a significant part of revenue in 1-2 years
-possible insider selling or purchases (lock-up period ends October 13th)
*1:
( The delivery price war kicked off in February this year after JD.com entered the delivery market; Meituan, Alibaba & JD have been offering free & virtually free (0.14 $) milk tea by delivery to gain market share & costumer loyalty
While Guming, Mixue and Luckin coffee have benefited from this competition, Chagee has suffered and lost market share
Chagee has not been participating in the “0 Yuan milk tea” competition to maintain their premium brand position
-even as premium tea brand it’s difficult to compete with free drinks
-still over 50% of Chagee’s GMV in Q2 came from 3rd party delivery, indicating the importance of delivery services in Q2 for the milk tea market;
-as Chagee did not participate in the 0 yuan subsidies & similar promotions, they were disadvantaged in the search results of the delivery platform
-the e-commerce platforms are burning through money, so this can’t go on indefinitely. Competition will continue, but has peaked and will start to ease from here. Even the CCP got involved actively to curb in these price wars, so the worst is over.
-Q1 2025 was partly and Q2 fully impacted by this price war
-the price ware peaked in July, ie Q3 will also be affected by this
CHAGEE has a long-term brand strategy to create high brand value "by winning consumers instead of just by cutting prices”)
Thanks for writing this up, nice work :)
If continue -7% QoQ for 10,000 quarters :
At the end of 10,000th quarter,
The decline TTM will still the same.
.
i .e. store sales @10,000Q TTM over store sales @9996Q TTM
= (1-0.07)^4
= 0.74805201
.
Decline
= 100×(0.74805201-1)
= -25.194799 %