E-Cigarette Tax Rate May Rise to Match the 80% Cigarette Tax Rate

Interpretation, Review, and Projection of E-Cigarette Policies:

(1) Recent Policy Interpretation: Regarding the implementation of the "Tobacco Monopoly Law" starting on November 26 and other events, we are more optimistic about the industry's development compared to market views. We believe that the regulatory body is clear, and the biggest uncertainty in the e-cigarette industry, the risk of a one-size-fits-all approach, has been mitigated, confirming the legitimacy of private capital's participation in the industry chain. Under the backdrop of regulatory norms, the industry is expected to accelerate penetration and achieve high-quality development. Market concentration is expected to increase. Future policy focus will be on the details of the "Tobacco Monopoly Law" and the national standards for e-cigarettes, which are expected to be implemented within six months.

(2) Review of Policy and Regulatory Attitudes: Focus on three major directions of e-cigarette policies: By reviewing the changes in regulatory attitudes, we believe that the future policy attitude is likely to remain supportive of domestic new tobacco research and innovation, uphold the bottom line of protecting minors, promote orderly industry development, and ensure national fiscal revenue. Therefore, we focus on three directions for policy implementation: improving market access mechanisms, restricting flavors, and increasing e-cigarette tax rates.

(3) Policy Projection: By referencing policy changes and market responses in Japan and the United States, we attempt to project three major policy trends for the future:

1) Improve market access mechanisms, establishing a licensing/qualification management system for each segment. This specifically involves three segments of the industry chain: in production and wholesale, it is expected to promote an increase in industry concentration, while in retail, it may promote the standardization of terminal sales, thus addressing issues such as inconsistent product quality and chaotic pricing systems. Additionally, three major transformations that may occur in the industry in the future are worth noting: terminal stores transforming into collection stores, where the product strength, brand strength, and packaging advantages of brand owners may become prominent; brand owners may focus on a single segment, considering the difficulty of obtaining multiple licenses under the cigarette system and the weakening of channel advantages for brand owners under the collection store model; agents may transform into service providers, shifting their profit model from solely earning product price differences to earning brand service fees.

2) Flavor Restrictions: Based on the market response after the flavor ban in the US, we believe that the conversion of smokers' preferences is likely to succeed, and the impact on domestic market growth may be lower than expected;

3) Tax Rate Increase: Referring to Japan, the tax rate may rise to 80% of the cigarette tax rate, and the impact of e-cigarette taxation on fiscal revenue is limited.

Future Outlook for the E-Cigarette Industry: In the short term, the industry may see improvement in Q4, while in the long term, leading tobacco companies are accelerating their transition to smoke-free products.

(1) Domestic Market: From the operational situation of terminal stores, after the release of the draft for public opinion on the "Tobacco Monopoly Law" in the first half of the year, from April to October, the operational situation of e-cigarette terminal stores continued to decline due to accelerated channel expansion by brand owners, increased store density, and channel competition. The decline in Q3 has slightly slowed, and it is expected that after e-cigarettes are formally regulated like traditional cigarettes, the operational situation of e-cigarette stores will improve in Q4. In the HNB market, China Tobacco's overseas trial sales are accelerating, with Sichuan China Tobacco expanding its market to Europe and New Zealand and opening a Kung Fu experience store in Malaysia to enhance brand influence overseas. The development expectations for domestic HNB products are likely to boost, with Yunnan Tobacco's new product "Double Sound" currently in a slow sales phase. It is anticipated that domestic HNB manufacturers will steadily follow up under the expectation that subsequent policies will be implemented within six months. In the vaping market, the revenue of Vaping Technology in Q2 has slowed down, while the leading position of domestic brand owners remains solid, with a market share of 45% for closed vaping devices in 2020.

(2) International Market: In the short term, following the milestone event of the first PMTA approval on October 13, regulatory policies for e-cigarettes in various countries are accelerating. E-cigarettes in the UK are expected to be included as prescription drugs to assist in quitting smoking; Malaysia's vaping e-cigarettes are expected to become legalized. In the long term, leading tobacco companies abroad are accelerating their transition to smoke-free products and are confident in the long-term development of new tobacco. In May, PMI's new CEO, Jacek Olczak, stated that the company plans to gradually exit cigarette sales over the next 10 to 15 years, expecting to achieve this first in Japan and transition to a smoke-free society. PMI's HNB product penetration rate has been continuously improving in Q1-Q3, with positive trends across various indicators. British American Tobacco's market share of new tobacco products is also increasing, with a continuously expanding user base.