11 Key Points to Fully Understand the E-cigarette Industry and Its Regulatory Direction

1. Concept

E-cigarettes are mainly divided into two types: atomized e-cigarettes and heated tobacco products.

Atomized e-cigarettes generate aerosol particles by heating e-liquids containing nicotine, flavorings, and other substances; heated tobacco products achieve reduced harm smoking by heating thin sheets or tobacco strips made from tobacco.
 
Additionally, traditional tobacco in China not only satisfies the craving for smoking but also has a social attribute.

2. Market

In 2019, global revenue from atomized e-cigarettes reached $20.2 billion. Based on a domestic base of 350 million smokers, the e-cigarette market has considerable space, conservatively estimating that China's e-cigarette market could reach 30 billion yuan.

Compared to the global market, China's e-cigarette penetration rate is currently not high. The penetration rate of e-cigarettes in the U.S. reached 31%, while in 2019, China's e-cigarette penetration rate was only 0.6% (according to Euromonitor statistics).

In terms of competitive landscape, RELX's conservative market share exceeds 40%, with CR5 around 70%, indicating a high concentration. Currently, the leading brand of atomized e-cigarettes in China is RELX, which achieved a revenue of 1.55 billion yuan in 2019, with a retail market share of 48%. The leading company in the value chain is Smoore International, the world's largest manufacturer of atomization devices, with FEELM atomization core technology leading the industry, holding a global market share of 16.5% in 2019.

Last year, the e-cigarette industry grew by 30% due to the pandemic.

3. Main Audience

A paper published by the Chinese Center for Disease Control and Prevention in the authoritative international medical journal The Lancet - Public Health, titled "E-cigarette Use Among Chinese Adults: Results from Two Cross-Sectional Surveys in 2015-2016 and 2018-2019," shows that the main e-cigarette users among Chinese adults are still traditional smokers, characterized by being male, heavy smokers, and wanting to quit smoking, with very few non-smokers using e-cigarettes.

4. Health Impact

In 2019, the 315 Evening Gala pointed out: "Like traditional cigarettes, the e-liquids used in e-cigarettes contain nicotine, and long-term use can also lead to addiction; the formaldehyde concentration in e-cigarette vapor is dozens to hundreds of times higher than the highest concentration of formaldehyde in indoor air, and a large amount of propylene glycol and glycerin has also been detected in the vapor, which can strongly irritate the human respiratory tract when converted into gas under heating conditions."

5. Regulation (China)

In August 2018, the sale of e-cigarettes to minors was prohibited;

In October 2019, online sales and promotion of e-cigarettes were banned;

In July 2020, a special rectification campaign for e-cigarettes was launched;

In March 2021, the Ministry of Industry and Information Technology publicly solicited opinions on the "Decision on Amending the Implementation Regulations of the Tobacco Monopoly Law of the People's Republic of China (Draft for Comments)."

6. Value Chain

In terms of cost and profit for e-cigarettes, looking at the terminal retail price of cartridges, RELX's gross profit margin may exceed 50%. The industrial chain of cartridges is relatively simple; for example, RELX cartridges can be summarized as Smoore International's factory-made devices + e-liquid + downstream retail.

RELX Selling Price = Smoore International's Factory Device + E-liquid Cost + Retail Markup
 
Currently, the revenue of e-cigarettes mainly comes from occupying a tax advantage in competition with traditional tobacco. Cigarette taxes mainly include value-added tax and consumption tax. According to data from the Chinese tax website, after 2015, cigarette taxes accounted for 56% of retail prices in China, and in 2018, domestic tobacco consumption tax revenue accounted for 55.8% of national consumption tax revenue, while e-cigarettes do not have to pay consumption tax, saving a significant portion of tax.

7. Industry Chain

The value distribution of the industry chain: the upstream of e-cigarettes includes raw materials and suppliers (value share of 13-17%), the midstream includes manufacturers and tobacco brands (value share of 23-31%), and the downstream value share is around 51-63%.
 
#p#分页标题#e#8. Why is regulation necessary?

1. Health issues: Preventing the smoking age from declining

E-cigarettes may create a "gateway effect" of tobacco addiction—using e-cigarettes may lead non-smokers to develop nicotine dependence and eventually become smokers. Among this group, adolescents are the primary victims.

2. Safety issues: Rectifying counterfeit and inferior products

The Chinese Center for Disease Control and Prevention states: "Currently, there are many e-cigarette brands and types on the domestic market, but we do not have standards for these products. Some people mention the danger of certain harmful substances being 'exceeded,' but we currently do not even have 'standards' to exceed. Establishing scientific and standardized industry standards is urgent."

9. Regulation and Rectification Direction

1. Referencing regulatory directions from Europe and the U.S.

United States: Policy measures focus on reducing youth smoking rates. The youth smoking rate in the U.S. has gradually increased since 2014, driven by brands like VUSE, BLU, and JUUL. In 2019, the number of youth e-cigarette users in the U.S. exceeded 5 million. As a result, in addition to PMTA, the U.S. mainly adopts flavor restrictions, raises the age limit, and imposes taxes to reduce the appeal of e-cigarettes to youth or increase the threshold and cost for youth to purchase e-cigarettes.

United Kingdom: E-cigarettes are an important tool for reducing smoking rates, and the government's attitude is relatively open. A 2015 study by the UK Department of Health found that e-cigarettes are 95% less harmful than traditional cigarettes. According to the UK Department of Health, there is currently no evidence that e-cigarettes will become a pathway for youth smoking, and every year, 20,000 people in the UK quit smoking through e-cigarettes. Based on this, UK policies focus on restrictions on content and marketing, maintaining an overall open attitude.

2. Analysis of optimistic and pessimistic scenarios:

Optimistic scenario: Similar to the U.S., a few industry leaders may obtain production and retail licenses after strict reviews; at the retail end, a special license for e-cigarette sales is established, and advertising follows tobacco management models, indicating a long-term growth trend for the industry;

Pessimistic scenario: It may completely follow traditional tobacco regulations, implementing production & sales monopoly systems, reducing opportunities for private enterprises to participate in the industry chain. However, considering employment and exports, this possibility is relatively small.

3. The domestic e-cigarette policy may generally have four directions:

1) Qualification certification;

2) Flavor restrictions;

3) Restrictions on e-liquid content or concentration;

4) Imposing e-liquid taxes/nicotine taxes.

10. Impact of Regulation on E-cigarette Valuation and Competitive Landscape

1. Related companies' profits will be affected by taxes and price limits.

Taxes: Currently, e-cigarettes are taxed like ordinary consumer goods, with a 13% value-added tax. Tobacco currently has a tax rate of 36%-52%, equivalent to 3-4 times the current e-cigarette tax.

Price limits: E-cigarettes may have a guide price for price limits. Currently, the maximum retail price for cigarettes cannot exceed 1,000 yuan per carton, which is 100 yuan per pack.

2. The production end will be affected.

If e-cigarettes are included in tobacco monopoly management, the production end must apply to the tobacco monopoly bureau for production and obtain a "Tobacco Monopoly Production Enterprise License" before production can occur, significantly changing the producer landscape.

The sales end will also be affected, with distribution and retail channels changing. Existing distribution and retail channels must obtain tobacco sales licenses to sell. Previously, the e-cigarette industry relied on offline retail channels without needing licenses, allowing for rapid development offline.

3. Short-term and long-term analysis

In the short term, the e-cigarette industry will face significant shocks, and the industry landscape may undergo another reshuffle;

In the long term, the industry will transition from wild growth to health, and regulation will not affect long-term growth. After the implementation of regulatory systems, the e-cigarette industry's operating model will align more closely with traditional tobacco models, intensifying competition among leading companies in offline channels, while further squeezing the survival space of smaller players. The implementation of regulatory policies will impact e-cigarette sales, but it may also benefit leading tobacco brands by deepening their ties with leading manufacturers, enhancing future business growth certainty, or increasing industry concentration, as leading companies are better positioned to develop products that meet regulatory requirements.

11. Is the e-cigarette industry a good track to pursue?

1. Referencing the world's largest e-cigarette supplier (Smoore International), leading companies will need high-tech e-cigarette supplies during their development process. However, domestic retail brands will depend on regulatory trends.

2. In terms of quantity and price, the likelihood of future tax increases is high, which will compress profits gained from prices. If policies can guide e-cigarettes to replace traditional cigarettes, there may be some growth in quantity.

3. Smoore International has a technological advantage in reserves and the ability to engage in price wars (if necessary), with strong bargaining power; 80% of its products are sold overseas (the U.S. is the main consumer of e-cigarettes).

4. Overall, the industry currently faces uncertainties regarding regulation, future flow (sales channels), and tax uncertainties. Any policy could deliver a significant blow.

5. From an investment perspective, one can refer to the gaming industry’s response to regulatory impacts. Since the tightening of regulations in 2018 (reduced licenses, restrictions on minors playing games, etc.), although gaming companies have improved their R&D and channel capabilities, valuations have continued to decline.