RLX Holds Breath As Illegal Vaping Slows Its Rebound

Key Takeaways:

• RLX’s revenue plunged 83% in the second quarter year-on-year, but was up from the previous quarter as it adjusts to a new regulatory framework launched last fall
• Despite complying with the new framework, China’s leading maker of vaping devices continues to face challenges from illegal rival products

By Edith Terry

Back in January 2021, RLX Technology Inc. RLX co-founder and CEO Wang Ying was riding high as China’s latest female billionaire after the nation’s biggest e-cigarette maker raised $1.4 billion in a New York IPO. Fast forward two and a half years, when much has changed and Wang’s net worth is far smaller.

The company’s latest results issued last Friday, including an 83% revenue plunge, show just how tough life has become not only for RLX but for China’s once-vibrant vaping industry in general. The company faces a tough road in the current landscape, as it attempts to claw its way back not only from a massive government crackdown, but also a current market clouded by illegal vaping products that often have an edge over RLX’s legal vapes and are significantly cheaper because they don’t pay a new excise tax.

Before we detail the company’s current challenges, we’ll take a quick step back two and a half years when its prospects looked far brighter. Backed by Hongshan, formerly known as Sequoia China, RLX commanded a breathtaking 62.6% of the Chinese vaping market by the time of its 2021 listing, three years after its founding in 2018, according to its prospectus. Wang walked away from the IPO with a puffed-up net worth of $24.8 billion for her 53.8% of the company’s shares.

But much of that went up in smoke just two months later after China’s Ministry of Industry and Information Technology warned that it would set strict limits on “alternative” tobacco products like vaping, sparking a 40% drop in RLX shares.

By last October, RLX shares had slumped 92% from their $12 IPO price. Today the Columbia MBA founder’s stake is worth about $1.23 billion, barely keeping her in the billionaire club, following the sale of some of her shares that has reduced her stake to 52.5% of the company, according to SEC filings.

The huge declines follow two years of intensive regulatory noose-tightening, most recently including a new 36% excise tax on vaping products that took effect last November. Just a month earlier, vapes of any flavor other than tobacco were banned – eliminating a youth market that is attracted by exotic flavorings. It didn’t help either that the industry was put under control of China’s state tobacco monopoly, which competes directly with the vaping industry.

But while Wang and RLX are down, they are certainly not out. Wall Street continues to stick by RLX despite all the challenges, with three out of four analysts who cover the company rating it as a “buy” or “strong buy,” according to Yahoo Finance. The four have an average price target of $2.74 per share, or nearly double the stock’s Wednesday close of $1.45. They expect its profits to return to a growth track next year as the regulatory dust settles, following an expected sharp decline this year.

The company’s second-quarter results showed it earned just 378 million yuan ($25 million) in revenue during the second quarter. While that was double the 189 million yuan from the previous quarter, it was a tiny fraction of the 2.23 billion yuan it reported in the year-ago period before most of the new measures took effect.

Improving Margins

The small silver lining in the report comes in steps RLX is taking to become more efficient in the face of its difficulties. The company’s operating expenses were just 47.2 million yuan in the second quarter, less than a tenth of the 530.9 million yuan a year earlier and also down sharply from 418.9 million yuan in the first quarter. But much of that was simply due to a decrease in share-based compensation costs.

The falling costs helped RLX to boost its gross profit margin to 26.1% in the second quarter from 24.2% in the first, though the latest figure was well below the 43.8% figure from the year-ago quarter. Its second-quarter net income of 205 million yuan was half the 442 million yuan from a year earlier, but compared favorably with a net loss of 56.3 million yuan in the previous quarter.

RLX shares rose by nearly 5% after the results came out, as investors may still see the company as a market leader that could emerge strongly once the regulatory air clears. Its price-to-earnings (P/E) ratio stands at a lofty 22, roughly the same as China Tobacco International (6055.HK), and above rival Smoore’s (6969.HK) 17.

While RLX will clearly need time to rebuild under the new regulatory framework, a major factor slowing that rebound lies in illegal products that flaunt the new rules, RLX said. The government was also cracking down on such illegal products, but wrapped up those efforts in April and May. Some of those illegal products are sold online, which is now illegal. Illegal operators are also making flavored products, which are now outlawed, to fit RLX vaping devices, robbing RLX of an important revenue source, the company said.

Chinese pharmacologist Hon Lik invented e-cigarettes in 2003 to help him stop smoking, and China now dominates the global market for the controversial product. About 1,000 factories in Shenzhen were making 95% of the world’s vaping and e-cigarette devices five years ago before many countries began cracking down on the practice, according to a report issued in 2018 by the China Electronic Cigarette Chamber of Commerce.

The industry was worth about 138.3 billion yuan in annual sales at that time. China’s e-cigarette factories were exporting 90% of what they made, according to 2020 IPO materials from Smoore International, a major maker of vaping components.

Illegal manufacturers have an edge over legitimate companies like RLX not only because they can make more popular flavored products and sell them online, but also because they escape the excise tax that legitimate companies must pay. CEO Wang, who also goes by the name Kate, called price competition from the illegals one of RLX’s biggest problems. “As a compliant participant in the e-vapor industry, we have continued to strictly comply with regulations, concentrating on improving our products to cater to users’ various needs and increase our competitiveness,” she said. “However, the negative impact of illegal products continues to pose a challenge.”

Despite the initial challenges, Sam Tsang, RLX’s head of capital markets, said the company remains “optimistic about the future growth of compliance products.”