The Chinese and foreign tobacco dualism looks at differences in tobacco research paradigms. On the one hand: tobacco taxes account for about 7% + of domestic finance in 2023. Against the backdrop of current economic pressure, domestic new tobacco policies are relatively conservative; on the other hand, in Europe and America, in 2023, along with the decline in tobacco tax revenue share (generally 0.5%-1%), ESG gradually became the number one priority, and policy friendliness was higher; on the other hand, the Chinese tobacco system has more than 0.5 million employees, and the regulation of tobacco products is far stronger than overseas; see that even though the US has restricted flavor products in 2020, it is still the largest new type of new type in the world Tobacco market; With the introduction of domestic tobacco policies, such as Yueke's new tobacco products in the domestic market, we believe it will be difficult to reach an inflection point in the short term. For overseas markets, on the one hand, along with the liberalization of overseas markets, compounded by the gradual growth of domestic tobacco, China Tobacco's overseas market has changed from an optional issue to a required topic. China Tobacco Hong Kong is the sole subject of China Tobacco's overseas, and the importance of the industry is unquestionable.

Under the new consumption situation, pay attention to the grand story of China Tobacco Hong Kong. Tax-sharing is the core KPI of China Tobacco's assessment. In the new consumption situation, we see that the past model that brought about tax revenue growth through product structure upgrades was unsustainable, and China Tobacco Hong Kong's importance in the China Tobacco system increased dramatically; China Tobacco Hong Kong's revenue/profit in 2023 was 11.8/0.6 billion yuan, respectively. As of October 16, 2024, China Tobacco Hong Kong's market value was only 12.1 billion yuan. Compared with global tobacco giants, China Tobacco Hong Kong's profit now comes more from China Tobacco's business transfers. Including the import and export of tobacco leaves and the duty-free export of cigarettes, considering that the increase in China Tobacco's market value in Hong Kong is in China Tobacco's interests, focus on more business allocation in the short term; in the medium to long term, the key to China Tobacco's success in going overseas depends on the taxable market. On the one hand, the increase in the share of new types of tobacco, users are less loyal to the market brand, giving new “players” a chance to break the game; on the other hand, in the context of the reshaping of the global landscape and the “Belt and Road”, they all create good opportunities for China Tobacco to go overseas.

Review the past history of Japanese tobacco and explore the taxable market opportunities for Chinese tobacco. Before 1985, Nippon Tobacco was a closed non-market-based enterprise; at that time, sales peaked and pressure from the US government forced Japan to abolish the monopoly system and carry out privatization reforms; with market-based operations and financial support from the Japanese government, the company began global tobacco mergers and acquisitions in the 90s, while continuing to improve its own marketing, supply chain and management. As of 2023, Japan's tobacco revenue/net profit was 142.7/24.2 billion yuan. It is the fourth largest tobacco group in the world, accounting for 76% of overseas revenue. Using this as an example, we will focus on the pace of restructuring China Tobacco's organizational structure, and in the context of new products & patterns, China Tobacco Hong Kong may increase overseas assets (production capacity/channels) mergers and acquisitions to enter overseas markets.

Investment advice: China Tobacco Hong Kong's performance is a bottomless company with room for imagination. Looking at the bottom of China Tobacco's overseas business allocation (90% from related transactions in 2023), China Tobacco Hong Kong's revenue has now reached the level of 10 billion dollars. In 2023, China Tobacco's total import and export business was only about 20 billion yuan, compounding China Tobacco's overseas assets. As a platform for integrating China Tobacco's overseas assets, China Tobacco Hong Kong is currently undergoing a transition phase from tobacco leaf traders to tobacco leaf production & cigarette production. Focus on the progress of overseas tobacco cultivation and processing and overseas cigarette production. In the context of China Tobacco's standardized management or acceleration of the asset injection process, the parent company's support forms the company's stable cash cow; from a long-term perspective, along with the gradual end of traditional domestic tobacco dividends, China Tobacco Hong Kong bears the heavy responsibility of China Tobacco's overseas business. In the context of a new global pattern/new product, China Tobacco Hong Kong may accelerate its entry into the taxable market for overseas cigarette sales through mergers and acquisitions of assets such as production capacity/channels/brands. In the context of epitaxial mergers and acquisitions, we expect net profit to be HK$0.85/0.99/1.152 billion for 2024-2026, respectively, and the corresponding valuation is only 14/12/11X. Compared with domestic and foreign tobacco industry chain companies, China Tobacco Hong Kong's performance/valuation has a lot of room for improvement. It was covered for the first time, giving it a “recommended” rating.

Risk warning: Overseas mergers and acquisitions fall short of expectations, increased industry competition, and exchange rate fluctuations.