Challenges Ahead for Chinese E-cigarette Industry

Last weekend, the parent company of leading domestic e-cigarette brand Yooz, Wuxin Technology, announced that it had received a production license. This means that all major domestic e-cigarette companies have now obtained production licenses. However, they still face numerous challenges ahead and cannot rest easy just yet. The information was originally reported by Securities Times.

Currently, there are nine e-cigarette brands in China that have been granted production licenses. Among them, Yooz (悦刻) has the highest number of pods produced at 328.7 million, followed by Xueke (雪加) with 77.3 million, Moode (魔笛) with 33 million, Platinum Vape (铂德) with 16 million, and Xiaoye (小野) with 12 million. Other brands produce less than 5 million pods. Yooz alone produces more than twice the number of pods produced by all other brands combined.

The licenses obtained by the company are significantly lower than the previous year's sales figures. According to data from Huachuang Securities, Wuxin Technology's sales of cigarette devices in the past three years were 4.3 million, 10.2 million, and 19.5 million respectively, with an average annual sales volume of 11.33 million. The approved amount of 15.05 million is equivalent to 77.18% of the projected sales volume for 2021. As for pods, sales over the past three years were 74 million, 213 million, and 506 million respectively, with an average annual sales volume of 264 million. The approved amount of 328.7 million is equivalent to 65.02% of the projected sales volume for 2021.

If Yooz's natural growth rate from the past three years is considered, it would have needed at least 1 billion pods for sale this year. However, only 328.7 million pods were approved for sale. This means that Yooz's natural growth rate was artificially halted, and suffered a significant setback.

According to the response from the Tobacco Monopoly Bureau regarding the determination of production scale for electronic cigarette-related enterprises, provincial tobacco monopoly administrative departments have uniformly organized personnel to conduct on-site inspections of production equipment nominal capacity, three-year average actual sales, and industry equipment capacity utilization rate. The tobacco monopoly administrative department has combined relevant data and actual situations to conduct comprehensive calculations and determine the approved production scale of enterprises.

Based on the actual approval results from YUEKE, the approved size exceeds the average sales volume over the past three years.

If all 328.7 million pods and 15.05 million cigarette sticks are sold according to the approved amount, the sales revenue would be approximately 5.5 billion yuan based on previous sales prices. Using last year's net profit rate, the company can generate approximately one billion yuan in net profit. Based on current market value, the price-to-earnings ratio is not high for a company with stable cash flow and growth potential in the future.

However, the issue is that these 328.7 million pods may not necessarily sell out due to the taste and distribution channels. In the future, Chinese tobacco will completely promote tobacco flavor and ban all fruit flavors. Previously, fruit flavors accounted for over 90% of sales and were a core reason why consumers used vapes. Most consumers are unwilling to go back to tobacco flavor, so it remains to be seen if tobacco-flavored e-cigarettes can retain customers and this will require some time to verify.

It is difficult to lift the ban on flavored e-cigarettes in the future mainly because currently, electronic cigarettes in China are primarily regulated and have to compete with conventional tobacco. Fruit flavors are seen as giving e-cigarettes an advantage, which hinders efforts to slow down their growth unless these flavors are prohibited.

Another factor is the distribution channels. In the past, the sales of electronic cigarettes were impressive due to both consumer education and the promotion carried out by opening brand stores. As more stores were opened, sales increased accordingly. However, with the loss of branded stores, electronic cigarette companies have lost their leverage, as electronic cigarettes are not allowed to be promoted and it's difficult for companies to stimulate consumption.

Limited retail stores need to maintain a certain quantity of products to cater to multiple brands. Currently, there are plans for approximately 50,000 electronic cigarette retail stores. However, the outlook for retail stores is uncertain, mainly due to declining sales of tobacco-flavored electronic cigarettes. Retail stores cannot offer bundled sales and are only able to sell electronic cigarettes. This makes it difficult to sustain a store, and many electronic cigarette stores are not planning to apply for retail licensure. Even if they do apply, if business is not good, they may close at any time.

Another major challenge is the taxation of electronic cigarettes. Industry insiders have reported that relevant departments have held meetings to seek opinions and propose a possible 36% consumption tax on production. Ultimately, these taxes will be passed down to end-users of electronic cigarettes, resulting in a potential decrease in consumer willingness to purchase due to the increased tax burden.