The Hong Kong stock market clearly picked up after the Spring Festival, and there was a small rebound. However, after four years of correction, Hong Kong stocks have become the most valuable investment depression in the world. However, undervalued ≠ good stocks. Performance is still a core element of investment, and underrated high-performing stocks are being explored by the market.

Over the past four years (2020-2023), the Hang Seng Index has continued to pull back, and valuations in most industry sectors have declined sharply, while the industry's white horse stocks have also become the hardest hit area, with a large number of undervalued high-performing stocks. Among them, as a unique example of the Hong Kong tobacco industry, China Tobacco Hong Kong (06055) is also following the trend of market capitalization, but its performance has stabilized. The bottom of the range consolidation and valuation has stabilized in the past year. Entering the allocation zone, high growth performance is reshaping the 2024 market capitalization trajectory.

The Zhitong Finance App learned that on March 8, China Tobacco Hong Kong announced its 2023 results, achieving revenue of HK$11.836 billion, an increase of 42% over the previous year, and net profit of shareholders of 599 million yuan, an increase of 60% over the previous year. In 2020-2023, the company's revenue and shareholders' net profit compound growth rates were 50.31% and 78.12%, respectively. In addition, the company paid a dividend of HK$0.32 per share, up 60% year over year, and proposed to pay an interim dividend starting in 2024 to create greater value for shareholders.

In fact, in the first year of its listing in Hong Kong, China Tobacco was sought after by capital, and its market value increased by more than 3 times. However, an epidemic occurred the following year, causing the valuation to continue to retreat. Under weak market conditions, liquidity is scarce, and stock prices are slow to respond to performance, leading to a divergence between market value and performance. The company's performance increased dramatically in 2023 and surpassed 2019. As the market continues to recover, it is expected to gain value discoveries.

Has exclusive management rights and increased performance

The Zhitong Finance App learned that China Tobacco Hong Kong is engaged in the import and export business of tobacco-related products and is the sole carrier for China's international tobacco business. The tobacco industry is different from other industries. The upper, middle, and lower reaches are basically managed by the country. For example, upstream material procurement. According to the Tobacco Monopoly Law, tobacco leaves are uniformly purchased by the Tobacco Monopoly Administration, while downstream sales activities are also planned by the National Tobacco Monopoly Administration to control tobacco monopoly licenses.

China Tobacco Hong Kong has exclusive rights to manage the relevant international tobacco business, and is basically responsible for the import and export business related to Chinese tobacco. The company operates five major tobacco-related businesses, including tobacco leaf product import business, tobacco leaf product export business, new tobacco product export business, and Brazilian business. The revenue shares in 2023 were 68.27%, 13.96%, 10.21%, 1.1% and 6.47%, respectively.

The tobacco import business is the company's basic market. In the past four years (2020-2023), the compound growth rate of the business reached 81.52%, and the incremental performance contribution reached 80.6%, driving China Tobacco Hong Kong's performance to maintain a high double-digit compound growth. It is worth noting that in terms of profit, the business also maintained a high contribution rate. In 2023, gross profit of the business was HK$732 million, gross margin was 9.06%, and gross profit contributed 67.3%.

The company's significant advantage is that it has no domestic competitors, so the tobacco import business can grow rapidly as macroeconomics and demand pick up. Furthermore, in addition to the tobacco import business actively playing the role of ballast stone, the company actively lays out the “cigarette and new tobacco export business”. Cigarette exports recovered in 2023, with revenue growth reaching 876%. New types of tobacco also recorded good performance. As business operations mature, multiple business growth drivers can be expected.

It is worth mentioning that China Tobacco Hong Kong is actively expanding overseas markets. The current overseas markets include countries such as Hong Kong, Indonesia, the Philippines, Egypt, Brazil, and Vietnam. Among them, China completed the acquisition of China Tobacco Brazil at the end of 2021 to improve the layout of the overseas tobacco industry chain. The company's business performance in Brazil was high, and profit margins were also high. In 2023, gross margin was 18.4%, and gross profit contributed 12.96%.

CBT, a non-wholly-owned subsidiary of China Tobacco Brazil, had outstanding performance. It will become a successful case of China Tobacco Hong Kong's overseas development and replicate the model to other regional markets. Most overseas countries have relatively relaxed tobacco market regulations, high commercial flexibility, and more market space. In fact, in addition to China Tobacco Brazil, the company also announced that it will enter business in the European region, or increase the layout of the overseas tobacco industry chain to accelerate the penetration of overseas markets.

Excellent assets, low liabilities, abundant cash flow

The nature of China Tobacco's business in Hong Kong is determined by focusing on asset-light operations, with a high proportion of variable assets. Its assets are of excellent quality. In 2023, cash on account (cash equivalents and short-term deposits) was HK$2.33 billion, accounting for 34.6% of total assets; in addition, the company had inventory of HK$2,974 million and accounts receivable of HK$908 million. Post-inventory sales achieved revenue conversion, while receivables were converted into cash flow during the accounting period, and the three types of cash equivalent assets together accounted for more than 92% of total assets. Furthermore, the company's goodwill generated through the acquisition of only HK$210 million, and the risk of future impairment is low.

Looking at the debt structure, the company's overall debt level is within a reasonable range, 60% in 2023. In terms of debt structure, it is basically current debt. Among short-term bonds, investors are most concerned about interest-bearing debt, which is HK$2.48 billion, including foreign exchange contract advances, export prepayments, and other loans, accounting for 36.8% of total assets. Currently, cash on the account can basically meet the payment of interest-bearing debt, but the company can also replace it in the short to medium term to optimize the debt structure.

In fact, the company's short-term debt is mainly the debt of China Tobacco Brazil. After the acquisition was completed in 2021, the company's share of short-term debt has always been very high. This is due to China Tobacco Brazil's CBT debt management and asset-light model. In addition, the cash flow situation for the half year was poor due to differences in the cut-off date of the financial statements and the production cycle during the smoking season, but the cash return for the whole year was stable, bringing the company's overall cash equivalent to over HK$2.3 billion in 2023.

China Tobacco Hong Kong's assets are basically operating assets, and the interest-bearing debt is not high, and China Tobacco Brazil's development model, which actually undertakes interest-bearing debt, can eliminate liabilities within the accounting cycle, have a healthy financial level, bring abundant cash flow, and leave sufficient guarantees for the company to develop new business and overseas markets. China Tobacco Brazil is the company's first overseas acquisition. In the future, it is expected to replicate this successful model and enter other overseas markets, especially in countries with fewer tobacco restrictions.

ROE increases linearly, and valuation is expected to return

China Tobacco Hong Kong has strong profitability. The shareholders' net interest rate level is increasing year by year. It was 5.06% and 4.29% in 2023, an increase of 0.56 percentage points over the previous year, and an increase of 2.02 percentage points compared to 2020. As analyzed above, the company's equity leverage ratio is not very high, but it obtained a high ROE level due to strong profitability. In 2023, it was 22.23%, up 5.47 percentage points year on year and 16.16 percentage points higher than 2020.

It is worth noting that 2021 was quite special. The main company's acquisition of China Tobacco Brazil generated a certain amount of revenue, while the sale of a joint venture generated revenue of HK$406 million, making the net interest rate and ROE significantly higher. If sales proceeds are deducted, the ROE level for the year was 16.86%, which increased linearly in 2020-2023. The ROE trend is good, which fully supports the high quality of the company's assets and strong operating capabilities.

China Tobacco Hong Kong pays dividends every year and actively rewards shareholders. The average annual dividend ratio exceeds 30%. The dividend rate dividend rate continues to increase steadily. The dividend ratio in 2023 is 36.8%. From 2021 to 2023, the company's dividends per share were HK$0.17, HK$0.2 and HK$0.32 respectively, with a compound growth rate of 37.2%, which surpassed most leading companies in the market. In particular, the increase in dividends in 2023 is actually an outstanding performance among Hong Kong stock countries/central enterprises. Against the backdrop of most countries/central enterprises generally cutting dividends, China Tobacco Hong Kong is far ahead, and its dividend payment amount has reached a record high over the years.

It is worth mentioning that the company was also favored by many investment banks, such as CITIC Securities, which released a rating report in January this year, covering China Tobacco Hong Kong for the first time and giving it a “buy” rating. Tianfeng Securities also published several research reports in 2023, saying that China Tobacco Hong Kong relies on China Tobacco Group and has significant barrier advantages. It is currently the only international business platform under China Tobacco. It is currently scarce and has business model advantages. It is expected to become a direct beneficiary of the development and transformation of China's tobacco industry. The company's continued high performance will also attract more attention from investment banks.

Overall, China Tobacco Hong Kong has exclusive management rights for China's tobacco imports and exports. Tobacco leaf imports are the basic business market, driving performance to maintain a high level of growth, and multiple businesses (cigarettes and new types of tobacco) are also gradually unleashing growth potential; under monopoly management, it has high bargaining power, continuous improvement in profitability, abundant financial health and cash flow, and steady business and market expansion. In addition, the company's ROE has increased linearly, dividend payments are stable, and good performing stocks.

The Hong Kong stock market ushered in the spring of “value investment” in 2024. As a unique example of the traditional tobacco industry and a high-performance stock with high-quality development, China Tobacco Hong Kong's valuation is expected to be revised.