- RLX Technology is the most relevant player in the electric cigarette market in China.
- I believe that market leaders usually grow more than the market. Note that RLX seems to be controlling 62.6% of the e-cigarette market in China.
- RLX saw that its assets increased by more than 1,200% in 2019 and 175% in 2020. Cash on hand also increased quite a bit.
- In the 9M ended September 30, 2020, the company reported cash flow from operations of $191 million, 313% more than that in the 9M ended September 30, 2019.
- RLX is enjoying a growing market in China and has a massive market share. If the company continues to spend millions in marketing, I would expect revenue to grow.
With more than 800% sales growth in 2019 and 81% sales growth in 2020, RLX Technology, Inc. (NYSE: RLX) is a dominant Chinese e-vapor industry player. With such massive sales growth, I wouldn’t say that RLX is expensive at 17x forward sales. With that, the company claims to offer unique technological advancements, which I don’t actually believe. In my opinion, the growth of the e-vapor industry in China and massive market expenditures are the main drivers of the company’s success story.
RLX Technology is the most relevant player in the electric cigarette market in China:
We deeply engage in the key activities in the e-vapor industry, from scientific research, technology and product development, supply chain management to offline distribution. Source: Prospectus
RLX was founded in 2018. The company received its first funds from Source Code Capital in 2018. In 2019, Hike Capital and Cambium Grove Capital also provided financing to the company. Notice the rapid development of RLX. It was founded in 2018, and in 2020, it appears to be the most relevant vendor of e-cigarettes in China.
RLX mentions in the prospectus that sales grew at a massive rate because the company’s technology is quite unique:
We believe our technologies are core to our success and are critical to our business. Our products are empowered by our proprietary technological innovations, such as e-liquid formulation, the engineering of the cartridge structure and the Essential Elements Solutions, to optimize adult smokers’ experience with our products. Source: Prospectus
I don’t know whether the company’s electronic cigarettes are way better than that of other competitors. However, according to the income statement, the company’s most significant expenses are selling and marketing. Research and development do not appear to be extremely relevant for the company. In my opinion, the company’s secret sauce is not the technology but its marketing expenses. It is just my opinion:
8% Of The Employees Are Executing Research And Product Development
According to the prospectus, 27% of the total number of employees execute general and administrative tasks, and 52% of the total number of employees perform distribution and customer services. Only 8% of the total headcount are executing research and product development. The company is called RLX Technology, but most employees are not creating any new technology. I would not expect extremely innovative products from the company. Don’t get me wrong. It does not mean that RLX may not generate tons of cash.
Use of Proceeds
RLX Technology noted in the prospectus that it would use the proceeds for the development of products, enhancement and distribution, supply chain and general corporate purposes. The company mentioned that 30% of the proceeds will be used for development of products and scientific research. It appears to be a significant amount of money. Take into account that only 8% of the total employees work in product development. I wonder whether the company, after the IPO, expects to increase the amount of product developers.
The Total Amount Of Assets Increased Significantly In 2019 And 2020
RLX Technology saw that its assets increased by more than 1,200% in 2019 and 175% in 2020. Cash on hand also increased quite a bit. In 2019, the company reported $19 million, and in September 2020, RLX had $40 million. Investors appear to be providing a significant amount of money to the company. There is a significant demand for the stock, which I appreciate quite a bit. If demand continues in the coming months, we will most likely see an increase in the share price.
Massive Sales Growth And Profitability Ratios
In the 9M ended September 2020, net sales increased by 81%, which is quite impressive. On December 31, 2019, sales also increased by more than 800% y/y. I am not sure whether RLX will be able to maintain the same sales growth in the coming years. If analysts believe that the company could do it, I would expect the valuation to grow.
That’s not all. The company is also profitable. Notice that the gross profit in 2020 is large. In the nine months ended September 30, 2020, the gross profit margin was equal to 20%. Besides, in the same time period, RLX Technology also reported a positive net income margin of 13%. The numbers seem extremely good. I don’t know why more analysts are not looking at the company’s financial figures.
Most analysts out there will appreciate looking at the cash flow statement of RLX. In the 9M ended September 30, 2020, the company reported cash flow from operations of $191 million, 313% more than that in the 9M ended September 30, 2019. As I mentioned, it will be tough for the company to report the same numbers in 2021 and 2022. With that, RLX appears to be selling products that have extreme demand:
Technology Is Very Important In The E-Vapor Market
In the annual report, RLX Technology disclosed that the e-vapor market in China focuses on technological innovations. Companies offering better technologies will most likely obtain a large market share. Besides, quality, distribution, and retail management appear to be very relevant factors:
Players in the e-cigarette are enjoying massive sales growth. Experts believe that the market will grow at 204% from 2018 to 2022, which appears quite impressive. Analysts believe that the market in China has an impressive potential:
Source: Daxue Consulting
According to the CIC Report, the e-vapor market in China amounted to US$1.5 billion in 2019 by retail sales value, and is expected to reach US$11.3 billion in 2023, representing a CAGR of 65.9% during this period. China’s e-vapor market is currently dominated by closed-system products, which accounted for 74.1% of the e-vapor market in 2019 by retail sales value, according to the CIC Report. Source: Prospectus
RLX Technology will most likely see sales growth in the coming years because the market is growing. The fact that the company appears to be a leader in the market will also help it. I believe that market leaders usually grow more than the market. Note that RLX seems to be controlling 62.6% of the e-cigarette market in China:
Valuation: 17x 2021 Sales
In the 9M ended September 2020, net sales increased by 81%, so let’s assume a sales growth of 31%, which is conservative. With this sales growth, I would expect 2021 sales to be equal to $600 million. In the nine months ended September 30, 2020, the company reported $324.2 million, so I believe that a sales target of $600 million could make sense.
We have experienced substantial growth with net revenues increasing from RMB132.6 million for the period from January 2, 2018 (date of inception) to December 31, 2018, or the 2018 period, to RMB1,549.4 million (US$228.2 million) for the year ended December 31, 2019, and from RMB1,138.9 million for the nine months ended September 30, 2019 to RMB2,201.3 million (US$324.2 million) for the nine months ended September 30, 2020. Source: Prospectus
With 1.553 million shares and assuming a share price of $25-30, RLX Technology would have a market capitalization of $38-$46 billion. If we assume 2021 sales of $600 million, the company trades at more than 17x sales. Taking into account the fact that in 2019, sales increased by more than 800% y/y, I don’t believe that 17x sales is an expensive valuation.
Upon the completion of this offering, we will have 1,553,315,570 ordinary shares issued and outstanding. Source: Prospectus
It isn’t easy to find other listed competitors in China that grow at more than 31% y/y. Competitors are not listed in the United States, so we cannot use them to assess the valuation of RLX. I checked the valuation of other technology companies from China. As shown in the image below, with revenue growth of 38%-149%, Chinese companies trade at 10x-49x revenue. Taking into account this fact, I don’t believe that the company is expensive at 17x sales.
Company-Specific Downside Risks
Investors need to understand that substantial risks are associated with RLX. Let’s add a brief discussion of the company-specific downside risks to offer a more balanced presentation. First, China prohibits the import and sale of heat-not-burn e-cigs. It is not ideal for RLX:
Overall, the Chinese government does not regulate vapes. While it prohibits the import and sale of heat-not-burn electronic cigarettes that are more similar to traditional cigarettes in flavor in fear that heat-not-burn electronic cigarettes would seriously impact traditional cigarettes’ sales. Source: Research And Markets
Besides, the company works with a significant number of distributors. If RLX cannot maintain its existing relationships, sales growth may decline. As a result, the share price could fall:
Our offline distribution and retail network plays a crucial role in bringing our products to adult smokers. We primarily sell our products to our distributors, supplying the products to retail outlets and users in China. As of September 30, 2020, we partnered with 110 authorized distributors to supply our products to over 5,000 RELX Branded Partner Stores and over 100,000 retail outlets nationwide, covering over 250 cities in China. We may have disputes with our distributors and retailers, and there can be no assurance that such disputes could be resolved in a timely or cost-effective manner or at all. Source: Prospectus
RLX Technology is enjoying a growing market in China and has a massive market share. If the company continues to spend millions in marketing, I would expect revenue to grow. I don’t believe that the company is expensive at 17x sales—companies from China with similar sales growth trade at similar valuations. In my opinion, the company represents an interesting buy-and-hold opportunity. With that, you will need to wait some years and may see a significant amount of volatility. If you are patient, RLX will most likely pay in the future.