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Elevator Pitch

I award a Hold investment rating to RLX Technologies Inc.’s (NYSE:RLX) stock. The current correction in RLX’s shares is fair, taking into account its weak Q1 2023 monetary overall performance which was impacted by regulatory adjustments. There is an absence of meaningful brief-term catalysts for RLX Technologies, as the company’s recovery path is anticipated to be lengthy. For that reason, I am of the view that a Neutral or Hold rating for RLX is suitable.

Organization Description

RLX refers to itself as “a major branded e-vapor corporation in China” in the company’s media releases. As highlighted in the company’s FAQs web page on its investor relations site, RLX Technologies was established in January 2018 and it only conducts its organization operations in China.

The company’s important corporate milestones and goods are detailed in the charts beneath.

RLX Technology’s Corporate Milestones

RLX’s Q1 2023 Earnings Presentation

RLX’s Positioning In The E-Cigarettes Sector Worth Chain

RLX’s Q1 2023 Earnings Presentation

RLX Technology’s Item Line-up

RLX’s Q1 2023 Earnings Presentation

Share Value Correction And Valuation De-rating Following Q1 2023 Outcomes Announcement

RLX Technologies revealed the company’s monetary overall performance for the very first quarter of this year final week on Wednesday Could 17, 2023. RLX has suffered from a important pullback in its stock price tag and a meaningful de-rating of its valuation multiples right after its most current quarterly outcomes release.

The company’s share price tag dropped by -17% from $two.44 as of Could 17, 2023 to $two.03 at the finish of the Could 25, 2023 trading day. RLX Technology’s final completed stock price tag was also -34% reduce than its 52-week higher of $three.06 recorded in the course of intra-day trading on December five, 2022.

RLX’s consensus forward subsequent twelve months’ Enterprise Worth-to-Income a number of de-rated from six.32 occasions on the Could 17 trading day to four.77 occasions as of Could 25 primarily based on valuation information sourced from S&ampP Capital IQ. Throughout the identical time period, the stock’s trailing P/B a number of compressed from 1.41 occasions to 1.18 occasions.

In the subsequent section, I clarify why I assume that RLX Technology’s current share price tag weakness is justified.

Regulatory Adjustments Have Hurt RLX’s Q1 2023 Monetary Efficiency

As indicated in the chart beneath, the e-cigarettes marketplace in China started to be regulated beginning in October 2022, and the Chinese regulatory authorities initiated an excise tax for e-cigarettes considering that November final year.

Current Regulatory Developments For The Chinese E-Cigarettes Market place

RLX’s Q1 2023 Earnings Presentation

The current regulatory adjustments for the Chinese e-cigarettes market have had a adverse influence on RLX Technologies organization as evidenced by its poor Q1 2023 monetary outcomes.

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

With China’s e-cigarettes market becoming regulated, a single of the important adjustments is that flavored e-cigarettes are no longer permitted to be sold in the nation. This implies that regulated firms such as RLX Technologies are losing marketplace share to illegal sellers which nonetheless distribute flavored e-cigarettes. At the company’s Q1 2023 outcomes contact on Could 17, 2023, RLX acknowledged that “enticing flavored, but unsafe and illegal goods brought on customers to shift extra gradually than anticipated to our GB (“Guo Biao” in Chinese referring to China’s national normal) goods.”

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

RLX Technology’s profitability at the gross profit level had weakened for two consecutive quarters, as its gross margin decreased from 50.% in Q3 2022 to 43.six% and 24.two% for Q4 2022 and Q1 2023, respectively. Offered that the excise tax on e-cigarettes was very first introduced on November 1 final year, RLX’s gross margin had begun to contract in the final quarter of 2022. With Q1 2023 becoming the very first complete quarter for which the excise tax is in impact, RLX Technology’s gross margin took a substantial hit and fell to much less than half of what it was for Q3 2022.

Issues Will not Be The Exact same Once more In A Regulated Atmosphere

The existing sell-side analysts’ consensus monetary projections for RLX Technologies recommend that the corporation will need to have significantly extra time to recover to the sales and profitability levels that it accomplished in the previous.

Prior to the regulation of China’s e-cigarettes marketplace, RLX’s fiscal 2021 income and gross margin have been RMB8,521 million and 43.1%, respectively. As a comparison, the consensus FY 2023, FY 2024, and FY 2025 leading line estimates for RLX are RMB2,599 million, RMB4,455 million, and RMB6,331 million, respectively as per S&ampP Capital IQ information. Separately, the market’s consensus monetary forecasts point to RLX Technologies reaching gross margins of 29.7%, 32.four%, and 36.% for FY 2023, FY 2024, and FY 2025, respectively.

In other words, RLX Technology’s sales and gross profitability are not anticipated to get back to pre-regulation levels inside the subsequent 3 years.

RLX admitted at its very first quarter outcomes briefing that “the adverse influence of illegal goods is nonetheless lingering, as it will take some time for the marketplace to digest inventories.” This implies that a swift income recovery for RLX Technologies is much less probably.

On the other hand, an optimization of RLX Technology’s income mix by rising income contribution from new larger-margin goods (e.g. chewing gum) will not be completely realized in the close to term. At its most current quarter outcomes contact, RLX emphasized that the majority of new goods are at the “pilot” phase with “minimal income contribution.”

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

Closing Thoughts

My rating for RLX is a Hold. RLX Technology’s monetary overall performance is anticipated to progressively enhance in subsequent quarters, as competitors from illegal cigarettes turn into much less of a headwind more than time and the corporation optimizes its sales mix by launching new higher-margin solution offerings in the future. On the flip side, RLX will locate it really hard to get its leading line and gross profit margin back to pre-regulation levels in FY 2021, so a substantial good re-rating of RLX’s shares in the brief term is much less probable. As such, a Hold rating for RLX Technologies is warranted.