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Elevator Pitch

I award a Hold investment rating to RLX Technology Inc.’s (NYSE:RLX) stock. The recent correction in RLX’s shares is fair, taking into account its weak Q1 2023 financial performance which was affected by regulatory changes. There is an absence of meaningful short-term catalysts for RLX Technology, as the company’s recovery path is expected to be long. Therefore, I am of the view that a Neutral or Hold rating for RLX is appropriate.

Company Description

RLX refers to itself as “a leading branded e-vapor company in China” in the company’s media releases. As highlighted in the company’s FAQs page on its investor relations website, RLX Technology was established in January 2018 and it only conducts its business operations in China.

The company’s key corporate milestones and products are detailed in the charts below.

RLX Technology’s Corporate Milestones

RLX’s Q1 2023 Earnings Presentation

RLX’s Positioning In The E-Cigarettes Industry Value Chain

RLX’s Q1 2023 Earnings Presentation

RLX Technology’s Product Line-up

RLX’s Q1 2023 Earnings Presentation

Share Price Correction And Valuation De-rating Following Q1 2023 Results Announcement

RLX Technology revealed the company’s financial performance for the first quarter of this year last week on Wednesday May 17, 2023. RLX has suffered from a significant pullback in its stock price and a meaningful de-rating of its valuation multiples after its most recent quarterly results release.

The company’s share price dropped by -17% from $2.44 as of May 17, 2023 to $2.03 at the end of the May 25, 2023 trading day. RLX Technology’s last done stock price was also -34% lower than its 52-week high of $3.06 recorded during intra-day trading on December 5, 2022.

RLX’s consensus forward next twelve months’ Enterprise Value-to-Revenue multiple de-rated from 6.32 times on the May 17 trading day to 4.77 times as of May 25 based on valuation data sourced from S&P Capital IQ. During the same time period, the stock’s trailing P/B multiple compressed from 1.41 times to 1.18 times.

In the next section, I explain why I think that RLX Technology’s recent share price weakness is justified.

Regulatory Changes Have Hurt RLX’s Q1 2023 Financial Performance

As indicated in the chart below, the e-cigarettes market in China began to be regulated starting in October 2022, and the Chinese regulatory authorities initiated an excise tax for e-cigarettes since November last year.

Recent Regulatory Developments For The Chinese E-Cigarettes Market

RLX’s Q1 2023 Earnings Presentation

The recent regulatory changes for the Chinese e-cigarettes industry have had a negative impact on RLX Technology business as evidenced by its poor Q1 2023 financial results.

Revenue for RLX fell by -89% YoY and -44% QoQ to RMB189 million in the first quarter of this year.

With China’s e-cigarettes industry becoming regulated, one of the key changes is that flavored e-cigarettes are no longer allowed to be sold in the country. This means that regulated companies such as RLX Technology are losing market share to illegal sellers which still distribute flavored e-cigarettes. At the company’s Q1 2023 results call on May 17, 2023, RLX acknowledged that “enticing flavored, but unsafe and illegal products caused users to shift more slowly than expected to our GB (“Guo Biao” in Chinese referring to China’s national standard) products.”

RLX Technology’s profitability also took a hit from the recent regulatory developments. RLX’s normalized net profit attributable to shareholders suffered from a -26% QoQ decrease and a -52% YoY drop in Q1 2023. The company’s bottom line for the recent quarter was adversely affected by the gross margin contraction resulting from the new excise tax mentioned above.

RLX Technology’s profitability at the gross profit level had weakened for two consecutive quarters, as its gross margin decreased from 50.0% in Q3 2022 to 43.6% and 24.2% for Q4 2022 and Q1 2023, respectively. Given that the excise tax on e-cigarettes was first introduced on November 1 last year, RLX’s gross margin had begun to contract in the final quarter of 2022. With Q1 2023 being the first full quarter for which the excise tax is in effect, RLX Technology’s gross margin took a substantial hit and fell to less than half of what it was for Q3 2022.

Things Won’t Be The Same Again In A Regulated Environment

The current sell-side analysts’ consensus financial projections for RLX Technology suggest that the company will need much more time to recover to the sales and profitability levels that it achieved in the past.

Prior to the regulation of China’s e-cigarettes market, RLX’s fiscal 2021 revenue and gross margin were RMB8,521 million and 43.1%, respectively. As a comparison, the consensus FY 2023, FY 2024, and FY 2025 top line estimates for RLX are RMB2,599 million, RMB4,455 million, and RMB6,331 million, respectively as per S&P Capital IQ data. Separately, the market’s consensus financial forecasts point to RLX Technology achieving gross margins of 29.7%, 32.4%, and 36.0% for FY 2023, FY 2024, and FY 2025, respectively.

In other words, RLX Technology’s sales and gross profitability aren’t expected to get back to pre-regulation levels within the next three years.

RLX admitted at its first quarter results briefing that “the negative impact of illegal products is still lingering, as it will take some time for the market to digest inventories.” This implies that a swift revenue recovery for RLX Technology is less likely.

On the other hand, an optimization of RLX Technology’s revenue mix by increasing revenue contribution from new higher-margin products (e.g. chewing gum) won’t be fully realized in the near term. At its most recent quarter results call, RLX emphasized that the majority of new products are at the “pilot” phase with “minimal revenue contribution.”

In a nutshell, RLX Technology’s top line and profit margins will naturally be lower in a regulated environment for e-cigarettes, so it is inevitable that RLX is assigned a valuation discount and its share price trends downwards.

Closing Thoughts

My rating for RLX is a Hold. RLX Technology’s financial performance is expected to gradually improve in subsequent quarters, as competition from illegal cigarettes become less of a headwind over time and the company optimizes its sales mix by launching new high-margin product offerings in the future. On the flip side, RLX will find it hard to get its top line and gross profit margin back to pre-regulation levels in FY 2021, so a substantial positive re-rating of RLX’s shares in the short term is less probable. As such, a Hold rating for RLX Technology is warranted.