China: E-cigarette Market

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Although invented and mostly produced in China (more than 90% of the global supply), e-cigarettes have never been popular in China until 2018/19. A combination of lack of consumer readiness and investors being scared of the reaction from the all-powerful China Tobacco (dual role: China National Tobacco Corporation as the state monopoly, State Tobacco Monopoly Administration as the industry regulator) led to the under-development of the market. For reference, in 2022, China Tobacco sold 2.46 trillion sticks (46% of global consumption) and generated $213Bn in profits & taxes for the central government (i.e. 7% of the total government revenue).

However, as the Western markets became more regulated and complicated to operate in (US FDA clampdown and EU TPD) towards the end of last decade, the (then-amplified) supply started to search for demand and found gold in the Chinese virgin e-cigarette market. The Chinese e-cigarette market experienced an explosive growth for a few years and took over the UK to become the second largest market in the world (after the US) in 2021 with $2.9Bn in annual retail sales. However, the fairy-tale didn’t last long: as e-cigarettes became visible, China Tobacco swiftly introduced measures to control the category. In Q3 2023 Earnings Release1, RLX Technology provided a concise summary of the regulatory developments in China – which started with the ban of online sales in Oct 2019, expanded with e-cigarettes being brought under the Tobacco Monopoly Law in Nov 2021 and finalized with the introduction of an excise tax in Nov 2022. Consequently, the (legal) Chinese e-cigarette market shrank to $1.7Bn in 2022 and is set to decline below $1Bn in 2023.

The Chinese e-cigarette industry is in survival mode now. The leading Chinese e-cigarette company, RLX Technology went public on NYSE in Jan 2021 and reached a peak valuation of $50Bn on its second day of trading. At the time of writing, RLX is worth $3Bn (despite a 25% gain in the last one week) – implying a shareholder value destruction of $47Bn from the peak (more than JUUL).

RLX’s 12M-rolling revenue is down to ¥1.33Bn ($185Mn) in the post-regulatory era from a peak revenue of ¥8.5Bn in the pre-regulatory era (i.e. -85% revenue decline from the Q4 2021 peak). Moreover, following the imposition of a 36% excise tax, the gross margin is down from 50% to 25%. At a run rate of $45Mn gross profit and $40Mn operating loss (despite the strategic cost optimization initiatives), the valuation of RLX is still rich considering the limited growth potential (due to the competition from illegal products and manufacturing quotas imposed by the State).

RLX’s last approved manufacturing capacity was 15Mn rechargeable devices, 329Mn pods and 6Mn disposables – which translates into ~340Mn packs of cigarettes (assuming 1 pack = 1 pod = 1/2 disposable). The Chinese cigarette market is 120Bn packs; thereby, RLX’s approved share is less than 0.3% of the market. At the time of the IPO, RLX claimed to have more than 60% share in the Chinese e-cigarette market. It’s difficult to know how RLX’s share has evolved since then; nevertheless, it still remains as the leading player in the (legal) market. Thereby, we assume that e-cigarette market is legally capped at less than 1% of the cigarette market in China.

The future of the Chinese (legal) e-cigarette market depends on the operating freedom offered by China Tobacco (or, in other words, on the mercy of State). If we need to make an educated guess, e-cigarette volume may be allowed to reach 2% of the cigarette volume by the end of this decade (2030) – capping the category to 2.4Bn pods or $3.6Bn retail value (including the devices). Thereby, RLX’s net revenue is likely to remain at a fraction of the Q4 2021 peak in the years to come.


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