RLX Technology: Regulatory Clarity Awaits

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A quick look at RLX technology

RLX Technology (RLX) went public in January 2021, raising $ 1.4 billion in gross IPO revenue in the U.S. at a price of $ 12.00 for advertising, above the expected range of $ 8.00-10.00.

The firm manufactures indoor e-smoking devices for sale in China.

For “risky” investors who want to keep RLX for a long period, its bargain price may be too good not to let go. My view on RLX is to buy about $ 3.50 for advertising.

Note: RLX is a candidate for inclusion in my personal portfolio.

The company

The Beijing-based RLX company was founded to develop smoking products using electronic steam, and according to management, is the first seller in China, reaching a market share of 62.6% in retail sales in the nine months that ended September 30, 2020.

The leadership is headed by co-founder, chairman and CEO Ms. Ying (Kate) Wang, who was previously the head of Didi Youxiang and the head of Uber China at Didi Chuxing.

The firm has developed an offline distributor and a “branded store plus” retail model that employs more than 100 authorized distributors covering more than 250 cities in China.

In addition, the company uses its branded partner stores RELX to provide further access to a variety of retail stores such as specialty electronics, convenience stores and electronic pairs.

According to a CIC study commissioned and paid for by RLX, the company has more than 100,000 retail stores that provide at least one of its products, helping the firm take first place in brand awareness.

RLX Market and Competition

According to the ResearchAndMarkets market research report for 2018, the Chinese e-cigarette market grew from 1 billion yuan to 4 billion yuan from 2013 to 2017.

According to the report, “if 10% of 30-35 million Chinese smokers (out of about 350 million smokers in China) turn to e-cigarettes, the potential market size will exceed $ 15 billion.”

The main drivers of this expected growth are government initiatives to reduce smoking, as well as young demographic smokers who want to switch to potentially less harmful forms of smoking and prefer a variety of flavors.

Also, the Chinese government has a difficult relationship with smoking, as it sells traditional tobacco products to the public.

It bans the import and online sale of e-cigarettes without heating.

The company competes with traditional cigarette sellers, including the Chinese government and other e-cigarette firms in the fragmented industry.

In 2019, the government banned online advertising and the sale of e-cigarettes, so the company is undergoing regulatory changes that could negatively affect its ability to work.

Latest RLX financial figures

  • Topline revenue by quarters has grown significantly over the last 5 quarters, except for the 3rd quarter of 2021:

Total revenue for 5 quarters

Total revenue for 5 quarters (Looking for Alpha and Author)

Gross profit for 5 quarters

Gross profit for 5 quarters (Looking for Alpha and Author)

Operating profit for 5 quarters

Operating profit for 5 quarters (Looking for Alpha and Author)

  • Earnings per share (diluted) followed approximately the same trajectory as operating profit:

Earnings for 5 quarters per share

Earnings for 5 quarters per share (looking for alpha and author)

(Baseline for financial charts above GAAP)

Over the past 12 months, the price of RLX shares has fallen by 86 percent compared to the growth of the US S&P 500 index by 11.9 percent, as shown in the chart below:

52-week stock price

52-week stock price (in search of alpha)

(Source)

Evaluation metrics for RLX

The following is a table of relevant company capitalization and valuation metrics:

Measure

Amount

Market capitalization

$ 4,670,000,000

The cost of the enterprise

$ 2,840,000,000

Price / sales

3.87

Enterprise value / sales

2.22

Enterprise value / EBITDA

11.23

Free Cash Flow (TTM)

$ 207,700,000

Revenue Growth Rate (TTM)

215,31%

Earnings per share

$ 0.14

(Source)

As a reference to the public, the comparative will be Smoore International Holdings (OTCPK: SMORF); The following is a comparison of their main evaluation indicators:

Metrics

International Smurf (OTCPK: SMORF)

RLX Technology (RLX)

Dispersion

Price / sales

12.65

3.87

-69.4%

Enterprise value / sales

12.00

2.22

-81.5%

Enterprise value / EBITDA

26.41

11.23

-57.5%

Free Cash Flow (TTM)

$ 314,180,000

$ 207,700,000

-33.9%

Revenue growth rate

59.2%

215.3%

263.6%

(Source)

Commentary on RLX

In its latest earnings report, which covers the third quarter of 2021, management stressed that it believes that the government’s recent regulatory communications “will pave the way for long-term and sustainable growth in the sector.”

Founder and CEO Wang also mentioned her corporate social responsibility with an emphasis on age verification to prevent the use of her products under the age of 18.

The company has also launched a new brand targeted at adult smokers with a long history of smoking. The product has 8 tobacco-flavored cartridges designed for this large segment.

In terms of financial results, third-quarter revenue fell significantly due to negative advertising in China, restrictions on Walgreens teens and the COVID-19 outbreak in China.

However, management considers this decline in revenue temporary and continues to make great efforts in its categories of sales, supply chains and research and development.

The company spent the quarter focusing on existing distribution chains, proposing improvements or changes rather than adding new distribution.

Looking ahead, management believes that the e-cigarette industry is now in the “second half of the game” from a regulatory perspective with greater regulatory clarity, improved product safety and quality, genuine social responsibility and improved intellectual property protection.

In terms of valuation, compared to the much larger Smoore International, RLX trades at a big discount on various valuation metrics.

The main risk to the company’s prospects is the persistence of uncertainty regarding regulatory changes.

For example, new standards can reduce the maximum nicotine content to 2%, which will reduce some aspects of user satisfaction.

However, RLX presents a potentially exciting opportunity as downed stocks that may be nearing the end of the road due to regulatory uncertainty.

Preliminary results of the fourth quarter, described by management, show “consistent improvement in retail sales, as well as inventory management channels.”

For “risky” investors who want to keep RLX for a long period, its bargain price may be too good not to let go. My forecast for RLX is to buy about $ 3.50 for advertising.

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