Consumer Staples Author: Yangni Liu Editor: Luke Sheehan & Zhiqing Chen Mar 19, 2021 06:50 PM (GMT+8)

The tobacco industry has refreshed its business model during the modern era. E-cigarettes have become a hot catch, introducing consumers to a host of new companies stepping into the vaping market. However, only a few companies survived in what became a highly competitive business. Among them, RLX Technology is one of the most successful.

Impressive New York Trading Debut for Chinese E-Cigarette Maker RLX But Challenges Lie Ahead

● RLX Technology relied on flexible strategies while boosting its revenues dramatically in the last three years. Most of its revenue was from the sales of smoke cartridges. 

● Some external factors – such as low penetration rates and shifting tastes of smoking populations – also benefited RLX Technology.

● Different from other competitors, the e-vapor firm focused on diversifying its products and increasing R&D expenses. 

● Nevertheless, government prohibitions on the e-cigarette industry restricted RLX Technology's growth to some extent.

RLX Technology (RLX:NYSE) went public in New York at USD 12 per ADS on January 22, 2021. On the first day of trading, the vaping company's closing price reached USD 29.51, increasing 145.92% within one day.   

Set up in Shenzhen on January 2, 2018, RLX Technology provides e-cigarettes, focusing on closed-system devices. After three years of development, the firm's selling network had covered 150 cities, 110 authorized dealers, and 5,000 brand specialty stores by the third quarter of 2020.

Financial analysis

RLX Technology has shown a continued upward trend in its profitability over three years, even under the government's ban on online sales and the effects of COVID-19. 

From 2018 to 2020's first three quarters, the e-vapor firm's main operating incomes rose from CNY 130 million to CNY 2.2 billion, with a growth rate of about 1592.3%. Surprisingly, after setting up, its net incomes were always positive. Regarding RLX Technology's revenue structure, the smoke cartridge sales contributed significantly to its core income, due to its low unit prices. The other income source was from extra supporting equipment – which was less than half the smoke cartridges' sales volumes. The ratio of the smoke cartridge to equipment was around 12.93 during these three years. 

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The e-cigarette industry has attracted massive players. For instance, new vaping firms numbered around 30,000 units in 2019. RLX Technology quickly captured the market by cooperating with Smoore International – a vape manufacturer that owns its own exclusive factory to realize mass production. As a result, RLX Technology has occupied 62.6% of the market share in China's closed-system e-cigarette industry. To be more specific, the difference between open and closed-system devices lies in the way of e-liquid being delivered to the heating mechanism. Open-system e-cigarettes have a clearomiser filled with e-liquid manually, whereas closed-system ones utilize refills. 

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Industry analysis

RLX Technology's rapid growth derives from four main external opportunities – China's low penetration rates in the e-cigarette industry, e-cigarettes increasing market share, a rising closed-system e-cigarette market, and China's large smoking population, which prepares consumers to switch to vaping. 

The first factor has to do with leading penetration rates among different nations. Unlike developed countries with surging trends in the vapor market, RLX Technology's average increase rate was merely about 0.44% in the last seven years. To be more precise, China's penetration rate was 1.2% in 2019, much lower than the US's and UK's 32.4 and 50.4. Hence, there is considerable room for e-cigarettes to grow and replace traditional cigarettes in China.

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Second, the company's e-cigarette market shares have strong prospects for expansion in China. 90% of e-cigarettes' production was from China since 2016, while the US occupied 57.1% of e-cigarettes' consumption side in 2019. Benefiting from China's low penetration rates, its retail sales will keep increasing, and it is expected to reach USD 113 billion by 2023.

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Third, the closed-system e-cigarette market will account for a larger share in China. The closed-system e-cigarettes have gradually become the mainstream product type since 2019, occupying 73.33% of China's whole market. RLX Technology's success also benefited from the emphasis on this specific area by innovating the closed-system e-cigarettes.

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Last but not least, China's large smoking population will push the company to a more optimized position. Up to 2019, China had the largest number of smoking adults – about 286.7 million people, four times more than the second nation, Indonesia. This situation indicates a potentially enormous consumer market stemming from China's cigarette industry. 

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Internal advantages

Except for the above favorable factors, some internal advantages should not be overlooked either. To begin with, RLX Technology has outstanding technological strengths. Since being founded, RLX Technology has been gradually improving its R&D ability. Specifically, its R&D expenses have risen from 2018's CNY 2 million to the third quarter of 2020's CNY 90 million. Meanwhile, the firm applied for 425 patents globally, much higher than other players. 

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Another strength is its diversified products. Based on its efforts in R&D, the vaping firm's products become ever more diverse. For instance, its prices range from CNY 39 to CNY 450 with diverse flavors of e-cigarette in different price ranges. Moreover, its new product named – Yuekeqingfeng – was released on March 3, 2020. Its price was lower than CNY 50 but with good quality. To ensure the quality, RLX Technology required 18 testing processes before it left the factory. 

The last thing is RLX Technology's fundraisings that have supported its expansion. Before going public on the NYSE, the firm was actively seeking capital injections. Before September 2020, it had raised a total of USD 3,02 billion in seven venture capital rounds. As for its IPO, RLX Technology utilized 30% of capital raised for product development and 25% for its retail network expansion. 

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Risks

Although RLX Technology has earned a significant mass of profits, it still faces several risks these days. Firstly, high debts. When looking at its balance sheets in detail, its average asset-liability ratio was close to 91.33%. Furthermore, its ratio of current liability to total liability also reached 80.1% in 2020, indicating the firm's low debt-paying ability. Once the debt maturity ends, it will be a disaster for RLX Technology's capital flows. 

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Secondly, regulation issues. In China, regulation has always been a potential threat for e-cigarette companies. Since 2018, Chinese governments have enacted four laws to prohibit selling cigarettes to teenagers and also to ban online sales. The truth is that the e-cigarette's product design and brand concept were easy to attract teenagers, how to avoid offline stores to sell e-cigarettes will be a challenge for RLX Technology.

Bottom line

With fabulous packaging and novel concepts, RLX Technology's appearance did attract a crowd of young people in China. Moreover, when facing some emergencies, its management layers could come up with flexible strategies immediately, which helped the vaping firm to make profits. However, after going to IPO for two months, its share price dropped to USD 18.8 in early March, showing a downward trend for its stocks. The company remains attractive though, with undeniable growth potential.

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