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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 economic efficiency which was impacted by regulatory adjustments. There is an absence of meaningful quick-term catalysts for RLX Technologies, as the company’s recovery path is anticipated to be lengthy. Consequently, I am of the view that a Neutral or Hold rating for RLX is acceptable.

Corporation Description

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

The company’s essential corporate milestones and goods are detailed in the charts under.

RLX Technology’s Corporate Milestones

RLX’s Q1 2023 Earnings Presentation

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

RLX’s Q1 2023 Earnings Presentation

RLX Technology’s Item Line-up

RLX’s Q1 2023 Earnings Presentation

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

RLX Technologies revealed the company’s economic efficiency for the initial quarter of this year final week on Wednesday May possibly 17, 2023. RLX has suffered from a considerable pullback in its stock price tag and a meaningful de-rating of its valuation multiples soon after its most current quarterly outcomes release.

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

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

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

Regulatory Alterations Have Hurt RLX’s Q1 2023 Economic Efficiency

As indicated in the chart under, the e-cigarettes market place in China started to be regulated beginning in October 2022, and the Chinese regulatory authorities initiated an excise tax for e-cigarettes because November final year.

Current Regulatory Developments For The Chinese E-Cigarettes Marketplace

RLX’s Q1 2023 Earnings Presentation

The current regulatory adjustments for the Chinese e-cigarettes sector have had a unfavorable effect on RLX Technologies enterprise as evidenced by its poor Q1 2023 economic outcomes.

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

With China’s e-cigarettes sector becoming regulated, 1 of the essential adjustments is that flavored e-cigarettes are no longer permitted to be sold in the nation. This implies that regulated businesses such as RLX Technologies are losing market place share to illegal sellers which nevertheless distribute flavored e-cigarettes. At the company’s Q1 2023 outcomes contact on May possibly 17, 2023, RLX acknowledged that “enticing flavored, but unsafe and illegal goods brought on customers to shift much more gradually than anticipated to our GB (“Guo Biao” in Chinese referring to China’s national typical) 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 reduce 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 described 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 initial 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 initial 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.

Items Will not Be The Identical Once more In A Regulated Atmosphere

The present sell-side analysts’ consensus economic projections for RLX Technologies recommend that the organization will will need significantly much more time to recover to the sales and profitability levels that it accomplished in the previous.

Prior to the regulation of China’s e-cigarettes market place, 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 major 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 economic forecasts point to RLX Technologies attaining 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 initial quarter outcomes briefing that “the unfavorable effect of illegal goods is nevertheless lingering, as it will take some time for the market place 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 growing income contribution from new greater-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 major line and profit margins will naturally be decrease 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 economic efficiency is anticipated to steadily enhance in subsequent quarters, as competitors from illegal cigarettes grow to be much less of a headwind more than time and the organization optimizes its sales mix by launching new higher-margin item offerings in the future. On the flip side, RLX will come across it difficult to get its major 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 quick term is much less probable. As such, a Hold rating for RLX Technologies is warranted.