Anxin International's First Coverage Report on China Tobacco Hong Kong

On June 21, Anxin International's WeChat public account released the inaugural coverage report on China Tobacco Hong Kong (6055.HK).

The summary of its content is as follows:

China Tobacco Hong Kong (6055.HK) is mainly engaged in tobacco leaf import and export, cigarette export, and new tobacco export business. The company was established in 2004, headquartered in Hong Kong, and serves as the designated overseas platform responsible for capital market operations and international business expansion for China Tobacco International.

The company's performance has continued to grow in recent years. In 23 years, the company's performance has reached a historic high with revenue of 11.8 billion Hong Kong dollars, a year-on-year increase of 42%, and a net profit of 690 million Hong Kong dollars, a year-on-year increase of 49%. The growth is strong. The company has announced a profit forecast, expecting revenue in the first half of the year to increase by no less than 10% and net profit to increase by no less than 30%. The main driving factors behind the performance growth include: 1) the continuous recovery of cigarette export business, leading to a significant increase in revenue and gross profit; 2) the tobacco leaf import business achieving growth in both quantity and price; 3) growth in revenue and gross profit of the tobacco leaf export business. This year, the company's overall development is good, with strong performance growth.

Hong Kong's core competitive advantage lies in its unique franchise rights: the exclusive operation of importing tobacco into the country. It also has exclusive rights to export Chinese tobacco to Southeast Asia, Hong Kong, Macau, and other regions. Additionally, the company exclusively exports domestic cigarette brands in Thailand, Singapore, China Hong Kong, China Macau, and other overseas regions. It also exclusively exports domestic new tobacco brands globally. Benefiting from its exclusive operations status, the company often utilizes back-to-back agreements with customers and suppliers, avoiding transportation, insurance costs, and lower exchange rate risks. With stable demand and supply conditions, the company's profitability is solid. In 21, the company acquired Zhongba Company, further expanding its business footprint through external mergers and acquisitions.

For the tobacco import and export industry, global tobacco production continues to decline, and tobacco prices fluctuate in cycles, currently in an upward cycle. Taking Brazil as an example, one of the main tobacco exporting countries, its tobacco export price decreased from $5.25 per kilogram in 2014 to $3.15 per kilogram in 2021, but rebounded to $4.19 per kilogram in 2022. Due to the influence of the El Niño climate, tobacco production is expected to continue decreasing in 2023, leading to a sustained increase in tobacco prices. The barriers to entry in the tobacco trade industry are high, the market is mature, and trading is relatively stable. China National Tobacco Corporation, along with the four major tobacco companies, hold a global market share of 83%, and for major tobacco traders, the number of clients is limited, as they have already established long-term partnerships. Additionally, traders typically require significant capital investment to control tobacco cultivation.

For cigarette export business, the recovery of passenger flow after the epidemic has driven an increase in sales. In general, global tobacco sales have been declining year by year, but due to the impact of the epidemic in 2020, tobacco consumption has actually been in a stage of recovery growth in recent years. The cigarette export volume of China Tobacco Hong Kong has rebounded rapidly after 2020, which is positively correlated with the number of outbound Chinese tourists. Currently, sales have not fully recovered to the level of 2019, but there is still room for growth. For new types of tobacco exports, the HNB market is growing rapidly, with promising development prospects. By 2023, the HNB market size will reach $34.1 billion, a year-on-year increase of 11.6%. The overall global cigarette market size is $927.4 billion, with the HNB market accounting for only 3.6%, indicating tremendous potential for development.

Overall, we believe that franchising has provided the company with a stable performance base. The rising price of tobacco leaves and the recovery in cigarette exports have both provided growth momentum for the company. In the future, the expansion of new tobacco business and possible mergers and acquisitions will serve as potential growth engines. Taking all factors into account, we anticipate that the company's revenue will reach 13.1/14.4/15.8 billion Hong Kong dollars in 2024/2025/2026, with a net profit of 904/973/1.086 billion Hong Kong dollars.

First coverage given a "buy" rating. Taking into account comparable company analysis and discounted cash flow valuation, a target price of 20.2 Hong Kong dollars is assigned.

Risk warning: Significant changes in the company's franchise operation status; weakening domestic demand for imported tobacco leaves; climate affecting tobacco planting in Brazil; declining tobacco prices.