Key investment points

Core highlights: China Tobacco Hong Kong is an exclusive operating entity designated by China Tobacco Corporation (CNTC) to engage in international business development platforms and related trade business, which guarantees the steady growth and profitability of the core business. At the same time, the overseas cigarette and new tobacco business is accompanied by a rich product matrix and opening up sales networks. In line with epitaxial expansion, future growth can be expected.

It is the only listed international business platform under China Tobacco Group, and the business is stable and has broad prospects.

An asset-light platform with a steady increase in profitability.

The company achieved revenue of HK$11.836 billion in 2023, with a revenue CAGR of 9% in 2016 to 2023. Although the business process was disrupted by global public health events, the growth path after 2023 was clear. Along with the optimization of the business structure and the gradual development of the company's supply chain advantages, gross margin increased from 5-6% in 17/18 to 11% in 2024H1. Asset-light operation, mainly inventory+accounts receivable. There are few fixed assets on the book, and accounts payable maintain a basic growth rate in sync with the company's accounts receivable. The supply chain is stable, and the operating risk is low.

Scarcity is strong, sole operating entities enhance bargaining power, abundant cash flow, and high ROE.

As an exclusive capital market operation and international trade development platform designated by China Tobacco Corporation (CNTC) under the national tobacco monopoly system, it is backed by China Tobacco Group and mainly deals in tobacco leaf import and export, and cigarette export business.

There is an exclusive right to operate the import and export of tobacco leaves outside of sanctioned regions (such as Zimbabwe). With its exclusive management rights, it has significant bargaining advantages for suppliers and customers, and stable profit margins. Net operating cash flow performance stabilized after 2023, and the company maintained a high ROE level, reaching 24% (diluted) in 2023.

The international business is developing smoothly, and the tobacco import and export trade has great potential.

Mainly imported high-end tobacco leaves, the trend of structural upgrading of domestic cigarettes is driving an increase in demand for high-quality tobacco leaves. It accounted for 68.26% of revenue in 2023, which is the company's main business. The share of domestic high-priced cigarette retail sales increased from 18.7% in 2015 to 21.6% in 2020, and the trend of high-end cigarettes continues to drive demand for high-quality tobacco products imported from overseas countries. In 2023, tobacco leaf import sales reached 117,216 tons, reaching a record high, with a year-on-year increase of 27.46%, gross margin of 9.1%. Demand for tobacco imports continued, and profitability continued to increase.

Tobacco exports are mainly domestic low- and middle-end tobacco products, and customer demand is stable. Tobacco leaf export customers are concentrated in Southeast Asian countries, Hong Kong, Macao and Taiwan, and there is a stable demand for domestic medium- and low-end tobacco leaf raw materials. According to sales agreements signed with suppliers and customers, the gross margin has stabilized at about 2.6%.

Cigarette export business: Revenue declined during global public health events and is expected to continue to grow in the future

The return of people entering and leaving the country after the global public health incident accelerated the recovery of cigarette export business. The cigarette export business mainly covers domestic and foreign duty-free channels. According to the prospectus, the domestic and overseas regions of China and Hong Kong, China accounted for 87% of the business in 2018, and the CAGR of revenue for 2020-2023 was 97%. The number of people leaving the country continued to rise after the global public health incident. The number of people entering and leaving the 2024H1 mainland reached 0.137 billion, up 71% year on year. Export sales of 2024H1 cigarettes reached 1106 million, up 96% year on year, revenue reached HK$547.3 million, up 128% year on year, and the recovery of cigarette export business accelerated.

Product portfolio optimization and introduction of high-end cigar products to help export demand and profitability continue to increase. In December 2023, the company introduced the “Great Wall” cigar brand, which has a market share of nearly 50% in the domestic handmade cigar market, and launched it in the Hong Kong taxable market, and the market response was good. 2024H1's gross profit reached HK$121.5 million, a year-on-year increase of 223%, and profitability continued to increase.

Taking advantage of the development of new tobacco products, domestic HNB exports continued to increase

The global trend of tobacco control and marine construction is accelerating, and the share of new types of tobacco continues to rise. The HNB market reached $34.1 billion in 2023, and the HNB market had a CAGR of over 23% in 18-23, growing rapidly.

Domestic HNB product development progress has accelerated, business and profit levels have grown significantly, and there is plenty of room for future development. As of 2018, provincial tobacco companies under China Tobacco have submitted 1,391 technical patent applications related to the manufacture of heated non-combustible products. Many international trading companies have shown strong interest in Chinese heated non-combustible products and are actively introducing them into overseas markets. The global sales CAGR of the company's new tobacco products reached 60% in 2019-2023. By 2023, the market coverage increased to 60, the number of dealers reached 104, and the new tobacco business reached HK$0.13 billion in 2023, up 18.1% year on year. The gross profit was HK$5.71 million, up 80% year on year.

By seizing growth opportunities in emerging markets and deepening penetration into key markets, the company achieved significant business growth and profit improvement.

Capital operations help expand overseas territory and accelerate industrial chain integration.

The acquisition of China Tobacco Brazil accelerated industrial integration, and its outstanding business performance became a new growth point. In 2021, China Tobacco Hong Kong followed the trend of strategic materialization and acquired China Tobacco Brazil, the original upstream tobacco supply channel, to begin the industrial chain integration process and enrich the company's business portfolio. The acquisition of China Tobacco Brazil launched the first step in the operation of foreign capital, and its international competitiveness gradually increased. China Tobacco Brazil's business revenue is growing steadily, with strong profitability and high potential for growth.

Revenue in 2023 reached HK$0.766 billion, the 2021-2023 CAGR was 56%, gross profit was HK$0.141 billion, and the 2021-2023 CAGR was 66%.

Profit forecasting and valuation

Overall, the tobacco import business is expected to increase steadily. The export business benefits from increased demand in Southeast Asia, the cigarette export business benefits from product structure optimization and inbound and outbound travel restoration. The new tobacco export business has full potential, and the Brazilian business continues to develop. As an international business platform under China Tobacco, the company continues to play an important role in subsequent industry integration. We expect the company's revenue for 2024-2026 to be 13.5 billion, 15 billion, and HK$16.5 billion, respectively, with year-on-year growth rates of 14%, 11%, and 10%, respectively; net profit to mother of 0.802 billion, 0.916 billion, HK$1.042 billion. The year-on-year growth rates are 34%, 14%, and 14%, respectively. Corresponding PE is 21.47X, 18.80X, and 16.53X, respectively. Considering the company's scarcity, The growth curve of the business is improving, and for the first time, coverage was given a “buy” rating.

Risk Alerts

The cost of tobacco leaves has increased dramatically, the risk of dependence on the monopoly system, and the impact of the global tobacco control movement.