Last year, only a handful of companies on the Hong Kong stock market saw their shares double, mostly those whose fundamentals had significantly improved. These stocks generally had previously low market expectations, and as concerns were dispelled, they experienced a considerable rebound from the bottom.

The e-cigarette industry has also been quiet for a long time. After the e-cigarette regulations in 2022, domestic demand continued to decline, and most companies in the industry inevitably experienced a decline in performance. Even today, most companies have still not been able to resume growth.

Under this premise, last year, $SMOORE INTL (06969.HK)$ it successfully increased by one time, and people began to feel optimistic, as if the bottom of the e-cigarette industry was near, and the stock prices of leading companies had already reflected this in advance.

Whether it is the suppression from the domestic supply side or the improvement in overseas demand, there are marginal improvements. Coupled with the company unveiling an aggressive Stock-based Incentive plan at the end of the year, which unlocks Options when the Market Cap reaches a performance target of 300 billion Hong Kong dollars, it further led people to believe there is a possibility for the company's stock price to return to 300 billion Hong Kong dollars, igniting a further surge in stock prices.

So is the current logic of the e-cigarette industry as optimistic as SMOORE INTL's stock price performance suggests? There is still a huge gap from the historical peak, is there still some opportunity in 2025?

I. Complete Globalization

In 2021, the booming electronic cigarette Industry faced regulatory adjustments; first, electronic cigarettes were deemed harmful, then the management measures prohibited the sale of flavored electronic cigarettes other than tobacco flavor, resulting in a collapse of sales in the electronic cigarette industry. Both RLX, which is directly facing consumers, and SMOORE, which does contract manufacturing, suffered heavy losses. Moreover, electronic cigarette stores that flooded online supermarkets have basically disappeared.

The strong regulation of the Tobacco Industry has led to an almost zero domestic market, but now, it is time to shed the burdens and start anew.

It can be seen that both SMOORE and RLX have begun to shake off the impact of the collapse in the Chinese market; in fact, the revenue proportion of these two companies from the China region has fallen below that from overseas, making them truly export-oriented companies. A few hundred million in Chinese revenue can no longer affect the overall income, regardless of how much it declines.

SMOORE’s overseas revenue proportion has reached over 90%, while RLX Technology’s is at 50%. The improvement in the fundamentals of these companies currently relies entirely on overseas markets, with zero expectations domestically, but it remains optimistic because even slight relaxations are free Options. For instance, RLX Technology’s Earnings Reports have already disclosed that the remaining bottom demand space for domestic electronic cigarettes after removing flavor factors has basically been clarified, and this business will maintain low base growth without dragging down the overall performance of the company.

Currently, these two companies have not disclosed the reports for the latest quarter, but based on relevant high-frequency data of customs electronic cigarette exports, it can be inferred that the performance in the second half of 2024 will be better than in the first half. Therefore, SMOORE's revenue is likely to warm up and rebound in the latest report, with expectations returning to around 12 billion, close to the 2022 level; however, due to the large one-time cigarette market in overseas business, which suppresses gross margin, the company's profits have yet to recover to the 2022 level.

The key point lies in the next couple of years, where the continued growth of overseas business will drive rapid increases in revenue and profit margins.

What is the current state of the overseas electronic cigarette market?

Overseas, there are not as many administrative restrictions as in China, yet the overseas electronic cigarette industry has also not seen the sustained high growth that was expected in 2020 over the past few years. SMOORE's overseas business has also not completely made up for the decline in the China region. From the revenue structure, only Europe and other regions have maintained growth, while the performance in the USA has been mediocre, experiencing declines over the past few years, dragging down the company’s growth rate.

The reason lies in the fact that disposable cigarettes have become mainstream in the USA, with lower technological content and flavor compared to cartridge-based e-cigarettes, yet they offer better cost-effectiveness. This is particularly attractive to economically disadvantaged youth, making low-priced disposable e-cigarettes a core element in promoting e-cigarette usage. For SMOORE INTL, as a manufacturer unable to dictate terminal demand, it has no choice but to produce disposable e-cigarettes, which has lowered the company's average transaction price and overall revenue, with a more significant impact on the gross margin, which has dropped from a peak of 53% to now 38% for this reason.

Disposable e-cigarettes, due to manufacturing process issues, are often less eco-friendly and safe, and can potentially harm minors, many of whom are smuggled. Most importantly, traditional tobacco giants' interests have been affected, prompting them to report to the government.

Therefore, starting from 2023, disposable e-cigarettes are facing a crackdown overall; for example, the UK banned disposable e-cigarettes in January 2024, while the USA has not banned them yet and is only intensively combating smuggled disposable e-cigarettes. This has resulted in a rapid recovery of some e-cigarette businesses in Europe, while the e-cigarette business in the USA has only stopped its decline and is slowly recovering.

However, it's evident that behind policies are interests, as relevant departments approved menthol-flavored e-cigarettes in 2024, indicating that flavor restrictions are not entirely strict, and youth health is not the utmost priority. Tobacco giants in Europe and the USA are still promoting the development of e-cigarettes; unable to sell in bulk via disposables, they are increasing the ASP of their products. This also sets up an optimistic outlook for technology-driven manufacturing companies like SMOORE INTL.

In the past few years, although SMOORE INTL's performance and gross margin have declined, the R&D pace has still been steadily advancing. Currently, the company's vaporization technology has also diversified from the tobacco field to the medical field. It can be said that the further the e-cigarette industry develops towards the high-end, the more beneficial it is for SMOORE INTL, which is also the key logic in the market.

In the coming years, under the profit-driven guidance of tobacco giants in Europe and the USA, policies will begin to push the proportion of disposable e-cigarettes to peak and decline, while closed system e-cigarettes will re-enter a stage of simultaneous quantity and price increase, thus allowing SMOORE INTL to begin enjoying a dual enhancement of revenue and gross margin.

But the key question is, how significant is this increase?

This is something to think about cautiously because cracking down on disposable e-cigarettes does not necessarily translate consumers' original demand into high-end closed system e-cigarettes. Most youths still lack funds, and banning disposables won't make them wealthier; at most, they will stop using e-cigarettes. Overall consumption will decline, and ultimately, the entire market's growth rate will not surge significantly due to an increase in ASP. For instance, in Europe, expectations remain modest, and the massive exit of disposable e-cigarettes in the short term has led to a downward outlook.

Therefore, Smoore's performance cannot rely solely on the tightening of the one-time electronic cigarette policy across the entire market, as the incremental gains are limited and it also relies on taking market share from peers.

Currently, everyone is placing more expectations on Smoore and the cooperation with major client British American Tobacco on the HNB new product Hilo becoming a blockbuster.

HNB, heating not burning tobacco, is more high-end than vaping, meaning higher ASP and gross margin. The global tobacco leader Philip Morris International's IQOS is an HNB product that has achieved very high sales of 12 billion USD, while other tobacco giants do not have comparable products. Now that the patent dispute in the USA has been resolved, British American Tobacco's Hilo will be launched next year. Based on the data, Smoore's Hilo in collaboration with British American Tobacco is better than IQOS and has the opportunity to capture market share. For example, half of PM's sales, 6 billion, may allow Smoore, which is manufacturing for them, to share over 10 billion in revenue, and estimating a 40% gross margin would yield an additional 4 billion in gross margin, which could almost double the gross margin this year.

This is also the most important reason why the company's performance has not rebounded, market cap has increased significantly, and management proposed 300 billion in stock-based incentive, because based on this expectation calculation, the company could potentially achieve record profits, returning to over 6 billion.

2. Cautiously view the incentives.

The company's stock-based incentive plan was recently launched, which is for Chairman Chen Zhiping, amounting to about 10% of the current shares.

The target is quite large, unlocking at 300 billion Hong Kong dollars, while the current market cap of Hong Kong stocks is only over 80 billion.

There have been many stock-based incentive plans, with the proportion of unmet targets far exceeding those that are achieved. This plan is based on market cap as a goal; generally, stock unlocks are more based on performance, such as revenue or profits, and rarely target market cap.

For management, revenue and profit are things they can strive for, while Market Cap depends on market sentiment. No Chairman would dare to claim they can achieve a 100% Market Cap, as that would be market manipulation. Market Cap targets can even be achieved through speculative trading.

In fact, reviewing the past, many companies have failed with Stock-based Incentive plans tied to Market Cap, so regarding this 300-500 billion target, it shouldn't be seen as bullish. It can only be said that the company is optimistic about the future, but the attitude is somewhat inappropriate, not paying enough attention to revenue and profit. This type of plan indicates that the company hopes to achieve a parabolic A-shaped performance, aiming for a sharp peak rather than a steady upward slow bull trend.

On the other hand, consider that the unlock plan's deadline is 2030, which gives 5 years to reach 300 billion. Calculating this amounts to a 30% annual growth rate, which is not significant compared to last year's 100% increase. It is believed that most SMOORE INTL shareholders currently do not regard a 30% annual return as appealing, nor would they hold shares for five years. They would prefer to hit 300 billion this year and then cash out.

For a high-performing stock, there needs to be both imagination and tangible aspects. By 2025, it is likely that SMOORE's performance will not have recovered to its previous peak levels. Hilo's significant contributions upon entering the market will not happen overnight, and other businesses will entirely depend on the recovery of e-cigarette sales in Europe and the USA. Revenue growth will not be particularly high, and while gross margin may improve, it won't be substantial, possibly only recovering to a 2 billion profit. Therefore, with a current 40 PE and low buyback dividends, this valuation is quite absurd within the entire Hong Kong manufacturing sector.

It can be said that the company is almost entirely supported by expectations surrounding a new product's volume, which leads to significant fluctuations and requires a continuous stream of positive news about new products to drive its value.

Finally, the expectation of significant performance growth driven by Hilo has a lot of uncertainties. What is the distribution ratio between SMOORE INTL and British American Tobacco? This figure is hard to calculate.

Generally speaking, this type of income depends on the profit distribution of the chain leader. The tobacco giants have a Market Cap of 100 billion USD, so one should not expect their Market Cap and profit to be surpassed. In terms of business models, they are also suppressing valuations, meaning valuations need to be lower. For Philip Morris International and BTI, which distribute full dividends, the dividend yield is relatively high, but US stock pricing PE is also unlikely to exceed 20 times. Therefore, the expected Market Cap of 300 billion for SMOORE INTL, even if projected as 10 billion profit times 30 times PE, may not be very reasonable.

The Tobacco industry may seem like a monopolistic superbusiness, but in terms of stock prices, it might not be the case. The growth of the giants over the past decade has been worse than many fully marketized consumer goods companies.

The core issue is that while Tobacco profits are high, there are enormous expenses related to policy adjustments and social moral compensation, which is why the profit margin for tobacco companies only reaches 20-30%, similar to that of consumer goods. All profits from these companies are distributed as dividends and excessive buybacks are mandatory, because the shares are mostly controlled by funds from Europe and the USA; ultimately, returns to pension funds circulate back to society. Most of the revenue must be returned to the government and residents.

As for SMOORE INTL, the situation is a bit nuanced. Firstly, apart from raw materials, the majority of costs are related to Chinese employees, which breaks away from the repatriation system of Europe and the USA. Secondly, in terms of shareholder structure, there is more Chinese capital involved, with very little foreign investment. This is actually a major issue, as policies in Europe and the USA monopolize the business; those who can purchase stocks have already been dissected once. Most of the revenue must be returned to society and the government, and the only ones really making good money are some 'white glove' companies acting as suppliers, but they are essentially fully controlled by the government and associated private capital; otherwise, money would flow out.

If SMOORE INTL is making a lot of money, it represents a disruption of this cyclical system. If SMOORE INTL were now heavily controlled by foreign capital, that would be acceptable, but that is not the case; the Stock-based Incentive plan is still targeted at individuals. As a Chinese company, the costs come from Chinese employees, and profit dividends also flow to China. Essentially, it earns money from the tobacco market in Europe and the USA at the expense of the health of youth in these regions. In the context of the great confrontation between China and the USA, this is difficult; even a slight touch on the funds from Chinese Tobacco by e-cigarettes is not permissible for either the Chinese or the Western governments, and expecting to earn core profits through collaboration with British American Tobacco or other European and American tobacco giants is unrealistic. It's more reasonable to play it safe and earn small profits.

Conclusion

So, regarding SMOORE INTL, it is true that the company is an excellent research-oriented firm; technically it is impressive, and its future imagination in the Medical field is vast. However, handling the Tobacco segment, where pollution is left to Europe and profits flow to China, is indeed exceedingly difficult. Tariffs and revenue sharing can all reclaim a substantial portion of profits. The focus is that, in comparison to the valuations of tobacco giants, maintaining a high valuation is quite challenging.

Setting aside the expected portions, the performance in 2025 will still be hard to sustain the valuation. The rise of SMOORE INTL's stock is more a combination of market capital and sentiment, driven by the demand for new products creating a surge in the market. However, current shareholders are unlikely to be willing to wait until 2030 for a 30% annualized return; it would be better if the rise happened all at once. Under such a model, the stock price should be clear to everyone.

编辑/jayden