CTIHK Luxuriates In The Shadow Of China's Tobacco Monopoly

The majority-owned unit of China National Tobacco Corp. reported double-digit profit and revenue growth last year, lighting a fire under its stock

Key Takeaways:

• CTIHK's profit rose more than 40% last year, as it banked on its monopolistic advantages in China's massive market for tobacco products
• Shares of the company, which is majority-owned by China's tobacco monopoly, rose 140% last year to record highs

It's well known that smoking is bad for your health, and the number of smokers worldwide is also declining. But that's not getting in the way of business for China Tobacco International (Hong Kong) Co. Ltd. (6055.HK) (CTIHK), the cigarette importing and exporting arm of China's tobacco monopoly, whose thriving business pumped up its profit last year by more than 40%, according to its latest annual results published earlier this month.

That strong performance has lit a fire under the company's shares, which rose 140% last year, significantly outperforming an 18% gain for the broader Hang Seng Index over that time. The gains have kept coming this year, as the stock continues to hit new record highs, marking the company as one worth following.

China's tobacco industry underwent major reforms in 2003, bringing together the State Tobacco Monopoly Administration, tobacco companies and cigarette producers in an overhaul that also produced CTIHK in 2004. The company was tasked with operating China's cigarette and tobacco import and export business in 2018 and went public in Hong Kong a year later. It's still majority owned by the nation's tobacco monopoly, China National Tobacco Corp., which holds 72.3% of CTIHK's shares.

China National Tobacco Corp. is China's only business engaged in the production and sale of tobacco, including imports and exports. The head of China's tobacco regulator, the State Tobacco Monopoly Administration, concurrently serves as the general manager of the corporation, and CTIHK is its only publicly listed unit. That unusual relationship between the nation's tobacco monopoly and its regulator often means that the harmful effects of smoking are publicized, but only half-heartedly.

Among other things related to its import and export business, CTIHK sells Chinese cigarettes to overseas companies, including duty-free shops and wholesalers, and also sells new types of tobacco products.

World's tobacco leader

China is, without question, the world's tobacco leader. It's the largest tobacco-growing country, with an output of 2.13 million tons in 2021, accounting for 36% of global production. Southwest China's Yunnan province is the country's largest tobacco-growing region, accounting for 40% of production. China is also the world's largest market for cigarette consumption.

But despite its own large domestic production, China mainly uses imported tobacco for its middle- to high-end cigarettes for taste-related reasons. Meanwhile, most of China's tobacco exports to Southeast Asia are low-end.

Despite its attempts to raise awareness about smoking's harmful effects, China's tobacco and cigarette market continues to grow quite robustly. According to Euromonitor International, the number of smokers in China fell from 278 million in 2009 to 276 million by 2023. But per-capita consumption of related products over that time doubled to 6,675 yuan as rising living standards led to more purchasing of higher quality products. The market was worth a massive 1.82 trillion yuan ($252 billion) in annual sales by 2023, up 120% compared with 2009.

Asset-light model

CTIHK uses an asset-light model that gives it virtually no fixed assets on its balance sheet and thus an average return on equity (ROE) of more than 20%. The company's revenue grew 10.5% year-on-year to HK$13.07 billion ($1.68 billion) in 2024, while its gross margin rose 1.3 percentage points and its net profit jumped 42.6% to HK$854 million. It rewarded its shareholders generously, distributing a dividend of HK$0.46 per share last year, up 43.8%.

Tobacco is the company's biggest import business category, contributing 63% and 60% of its revenue and gross profit in 2024. The company imports tobacco products from countries including Brazil, the U.S., Argentina and Canada, and distributes them to provincial-level companies in China.

The company is the only supplier of foreign tobacco and cigarette products in China, with no other access to the massive market for overseas suppliers. Such an arrangement puts CTIHK at a major advantage when negotiating with suppliers, including tremendous pricing power.

Still, the company's import volume dropped 4.5% last year to 112,000 tons. But that was offset by an increase in the aggregate sales price per unit. Cinda Securities data shows CTIHK's average sale price for its imported products rose as much as 24.4% in the second half of 2024, contributing to 2.2% growth in annual revenue and 12.7% gross profit growth for that part of the business to HK$8.25 billion and HK$826 million, respectively.

Heat-not-burn products as new growth driver

Heat-not-burn (HNB) products have become a major industry focus for traditional cigarette companies in recent years. Unlike traditional cigarettes, HNB products release nicotine and aerosol through the heating but not burning of tobacco, thus reducing the content of harmful substances such as tar. That lower harm level, combined with lower tax rates than traditional cigarettes, are making HNB products cheaper and all the rage lately.

The HNB market is highly concentrated, with Philip Morris (PM.US) the industry leader with 71% of the market. China has not opened up its market for such products, but CTIHK has been actively exploring such sales to overseas markets. Last year, the company's exports of new types of tobacco products rose 12.5% year-on-year, while its gross profit for that business rose 22.9%. According to Cinda Securities, CTIHK is pricing its HNB products at just one quarter of the unit price charged by the four top tobacco producers globally, which is likely to catalyze growth of its HNB business going forward.

Analysts polled by Bloomberg Data currently expect CTIHK's revenue to grow 14% this year. The stock now trades at a price to earnings (P/E) ratio of 18 times, trailing the 21.5 for Philip Morris, whose revenue is only forecast to rise 9% this year. That means that despite its recent price run-up, CTIHK's stock could still have some more potential upside.

The company has many factors going for it, from the relatively slow decline in the size of China's smoking population, to rapidly rising cigarette prices, and its position as the country's only cigarette importer and exporter. With the possibility of new business coming its way from its majority shareholder at any time, the stock looks well positioned to move on from its recent highs to even greater heights.