After three years of hitting rock bottom, the electronic cigarette sector seems to have emerged from its undervalued slump this year.

Intelligence Finance APP learned that the tobacco industry, which affects public health, has always been a heavily regulated industry in various countries. As a supplement to tobacco, the electronic cigarette industry has also been subject to many development restrictions. With increasingly stringent regulation in China and declining performance for most participants for three consecutive years, the electronic cigarette sector on the Hong Kong stock market has retreated by more than 90% in the past three years. However, the sector rebounded by more than 40% this year, and some targets have shown an improvement in their fundamentals.

Taking Smoore Intl (06969) as an example, the company's performance decline narrowed in 2023, and its earnings growth turned positive in 2024. Various brokerages have also issued research reports stating that the company's performance has bottomed out, particularly in the Chinese market, where the company's share awards plan has also been widely subscribed by trustees, indicating management and employee recognition of the company's development. The company's valuation has seen a significant rebound this year, nearly doubling in the past four months, but it is still down 90% from its peak and is still at a valuation 'ground zero'.

So, as an industry leader, will Smoore Intl achieve a 'double hit' of performance and valuation after hitting bottom?

Global policy regulation cannot stop the growth of the industry.

The electronic cigarette industry has grown rapidly in recent years, attracting many participants. However, due to the strict supervision in various countries around the world, there are many non-compliant electronic cigarette problems. Since 2022, China, the United States, and the United Kingdom and other markets have continued to increase their efforts to crack down on non-compliant and grey products. Taking China as an example, after the new "Tobacco Monopoly Law Implementation Regulations" was officially promulgated in November 2021, a "1+2+N" electronic cigarette regulatory system has gradually formed.

The market clean-up of non-compliant products has brought significant impact on compliant companies, but the elimination actually increases the concentration of the market, benefiting industry leaders. In addition, electronic cigarettes are deeply loved by the public for their varied flavors, and this aspect has also been subject to regulation. From the perspective of policies in various countries, in 2020, the United States' ban on flavored pod-based electronic cigarettes took effect, and in April 2022, China entered into an era of national standards, making regulations on electronic cigarette design, use of raw materials, assembly, and technical requirements in many areas, accelerating the exit of non-compliant brands, and bringing some impact on sales of flavored brands.

It is worth mentioning that although regulation is tightening in various countries, the electronic cigarette industry still maintains double-digit growth under the high profit margins of the industry. According to Sullivan data, the global market size of electronic atomization devices, calculated based on the ex-factory price, will be 11.511 billion U.S. dollars in 2023, with a compound annual growth rate of about 14.5% from 2019 to 2023. It is expected to reach 19.86 billion U.S. dollars in 2028, with a compound annual growth rate of 11.5%.

Closed-type electronic atomization devices account for more than 60% of the electronic atomization device market share, and they continue to maintain a double-digit annual growth rate in 2021 under the global intensified supervision. From the participants' perspective, Smoore Intl maintains its position as the world's largest manufacturer of electronic atomization devices, with a market share of about 13.7% in 2023. However, due to the substantial impact on the Chinese market, the market share has dropped by 4.4 percentage points.

The domestic risks have been eliminated, and autonomous and overseas development are the bright spots.

In fact, Smoore Intl is an ODM manufacturer, researching, designing, and producing closed-type electronic atomization devices for leading tobacco companies, independent electronic atomization, and other enterprise customers worldwide, with main income coming from ODM revenue. In addition, the company is also developing its own brand, such as the self-owned brand VAPORESSO, and actively expanding into new businesses such as atomization medical treatment and atomization beauty, trying to achieve diversified development.

Due to the intensified regulation worldwide since 2021, the company's revenue declined by 18.8% from 2021 to 2023, and net profit plummeted by 69.9%. From the market perspective, the most severe decline occurred in the domestic market, dropping from 5.53 billion yuan to 876 million yuan, down 84.2%. The U.S. market also declined by 28.8%. However, the company has expanded its market share in countries with less stringent regulation to counter risks, and its revenues in Europe and other regions have maintained growth, increasing its revenue share from 19.8% to 45.4%.

Under the "1+2+N" regulatory system, Smoore Intl cut its domestic market, which may not contribute to its short-term performance growth in the domestic business. The company's customer-oriented and self-owned brand atomization device products need to expand overseas sales channels. In 2023, it launched multiple new product lines to overseas markets and has operated five overseas warehouses in Europe and the United States, and established several overseas sales and R&D centers.

In terms of products, focusing on nebulization efficiency, higher suction port count, and improvements and upgrades in charging and battery life, the company invested approximately RMB 1.48 billion in R&D in 2023, with an R&D cost ratio exceeding 10%, mainly in medical nebulization products, heating non-combustion products, and disposable electronic nebulization products. For example, in the field of nebulized beauty products, in March 2024, the company launched its first technology-based skincare brand, MOYAL Lanzhi, and the sale of its misty brightening essence device products. This is the first time the company's core TPS transdermal technology has been applied in the C-end beauty field.

In terms of own-brand business, upgrades were made around the core experience pain points of open-ended products such as flavor, service life, and anti-leakage oil, and many new products were launched, creating the world's first intelligent electronic nebulization liquid supply system COSS, which has automatic liquid injection and automatic charging functions, and meets longer battery life. The performance of the independent brand business is eye-catching, and the revenue of the independent brand from 2021 to 2023 has maintained double-digit growth, with the revenue share increasing to 16.5%.

Nearly half of the assets are used for deposits, and the bottom valuation may return.

The company's independent brand and overseas markets are both important core growth points. However, according to Zhijun Finance APP, the company's major problem is the low utilization rate of its core assets, with most of its assets not focused on its core business. This has also led to a decrease in overall ROE levels, despite the high-profit nebulization equipment business.

According to Zhijun Finance APP, Smoore International has a core asset utilization rate of less than 30%, with most of its assets mainly used for financial management. As of December 2023, the company's operating assets, including property, plant and equipment, accounts receivable, and inventory, totaled RMB 7.345 billion, accounting for only 28.8% of total assets. In contrast, the proportion of short-term deposits and cash to total assets is as high as 67.4%, with deposits accounting for nearly 50%.

In fact, over the past three years, the company has done asset allocation between cash and deposits, and nebulization equipment has not done capacity expansion. Therefore, the market has basically been digesting past capacity, and overseas market demand has filled the part of the domestic loss. The deposit allocation mainly focuses on short-term deposits, with a staggering RMB 10.836 billion in short-term deposits in 2023, with interest alone costing RMB 515 million, accounting for 4.3% of total deposits and 26.6% of pre-tax profit. Excluding financial management and cash, although the company's core business has declined in recent years, the asset return rate in 2023 was nearly 20%.

More importantly, Smoore International has no bank debt, with mainly financial debts being lease liabilities, with annual financing costs of more than RMB 20 million, which is relatively stable. The e-cigarette industry chain has rich profits, and despite the decline in industry profits in recent years, the company's operating cash flow is still very abundant and is mainly in a net inflow state, with a net inflow of RMB 3.193 billion in 2023. In addition to meeting financing and other investment expenses such as dividends, this can also be used for financial management.

In terms of shareholder returns, according to Orient Choice data, since 2020, the company has paid dividends seven times with a cumulative dividend ratio of 27.62%. Based on its current market value, the dividend yield is not attractive, at only 1.1%. In addition, the company rarely repurchases its own shares to maintain its share price. Apart from a buyback in 2022, it has not repurchased its own shares on the secondary market since 2023. Apparent, the management may believe that financial management is worth more than buyback.

Overall, Smoore International's risks have bottomed out, with domestic market share declining to a single-digit percentage, but with limited impact on performance in a declining market, while independent brands and other products are diversified customer-side ODM risks and overseas markets are performing well. The overall trend is positive, especially the European market has become a performance benchmark. The first quarter of 2024 started off well, with most investment banks optimistic about the company and most giving a buy rating.

Smoore International has a low utilization rate of its core assets, which may suppress its valuation, making its asset return rate lower than the industry average. However, holding a large amount of cash mitigates its policy and market risks, and its valuation has significantly declined, digesting past performance bearishness and a clear bottom. Coupled with sector trends, its valuation is expected to recover.