Where does SMOORE INTL face challenges?

After the performance announcement for the first half of 2024, the stock price of SMOORE INTL (06969.HK) plummeted.

In the first half of 2024, SMOORE INTL's revenue decreased by 1.67% year-on-year to RMB 5.037 billion, with the largest market being the United States (including revenue re-exported from Hong Kong to the United States) decreasing by 7.68% year-on-year, offsetting the 4.82% year-on-year growth in revenue from Europe and other countries, which we will elaborate on below.

However, the company's gross profit margin for the first half of this year improved from 36.22% in the same period last year to 38.01%, with a 3.19% year-on-year increase in gross profit to RMB 1.915 billion. Nevertheless, SMOORE INTL increased its distribution and R&D investment, leading to a significant increase in operating expenses in the first half of the year, with distribution and sales expenses rising by 79.49% year-on-year, and R&D expenses increasing by 23.65% year-on-year, resulting in a 4.76% year-on-year decrease in the company's net profit attributable to shareholders for the first half of the year to RMB 683 million.

The main reason for the sharp drop in the stock price after the performance announcement is the underperformance compared to market expectations. However, there are different views on the outlook for SMOORE INTL from different financial media.

Signs of Improvement in SMOORE INTL's Business

SMOORE INTL's main business includes providing electronic atomization devices, heat-not-burn devices, and solutions for global tobacco giants, as well as offering its own brand of open electronic atomization devices.

In simple terms, SMOORE INTL mainly provides OEM services for electronic cigarette brands, which account for the majority of its revenue, while its own brand of electronic atomization devices contributes a smaller portion. The European and American markets account for the majority of SMOORE INTL's revenue.

In the past two years, various countries have implemented regulations on electronic cigarettes. China has mainly standardized the management of electronic cigarettes, mainly affecting the business prospects of terminal retailers (i.e., SMOORE's domestic end customers); while countries like Europe and America have tightened the approval of electronic cigarettes, affecting the business of SMOORE INTL's overseas market terminal brand customers.

As a result, SMOORE INTL's revenue and profit levels have fallen from their highs in 2021.

To address the above business risks, SMOORE INTL has increased its investment to expand the commercial use of its atomization technology beyond electronic cigarettes. Its R&D expenses have surged since 2022, as shown in the following figure.

In the first half of 2024, SMOORE INTL's R&D expenses increased significantly by 23.65% year-on-year to RMB 760 million, with the proportion of total revenue increasing from 12.00% in the same period last year to 15.09%. It is worth noting that in 2020, the year SMOORE went public, R&D expenses accounted for only 4.19% of its revenue, amounting to only RMB 420 million. Now, the R&D expenses for the half-year are equivalent to 1.8 times the annual amount at that time Where did the R&D expenses go?

The R&D expenses for the electronic nicotine delivery system still account for the majority of the R&D expenses. However, as shown in the chart below, the expenses for the research and development of atomized medical and beauty products surged in the first half of 2024, increasing by 63.23% annually to 185 million yuan.

In the field of atomized medicine, the company's inhalation drug subsidiary was established in the United States in 2021. By 2023, it had completed the development and production layout of three drug delivery devices for asthma and COPD, as well as the development of several drug formulations. The formulations and devices have been approved by regulatory agencies in Europe and the United States, and agreements have been reached with regulatory agencies on the R&D path of the products. They have entered the pre-clinical or registration batch production stage. In the field of atomized beauty, the company launched the MOYAL LanZhi brand and the first generation of atomized beauty product solutions in the first quarter of 2024. These non-smoking areas may open up new revenue streams for the company.

On the other hand, there are signs of improvement in SMOORE's main electronic cigarette business. After the first half of 2024 performance reporting period, the company announced that its important customer, Raynold Tobacco, had obtained marketing permits for 7 new tobacco products (including a battery) and 6 closed-system e-cigarette pods with tobacco flavors through the pre-market tobacco product application pathway. SMOORE INTL supplied these 7 products to Raynold Tobacco.

Furthermore, towards the end of the first half of the performance period, another customer of SMOORE INTL, NJOY LLC (a well-known tobacco giant under the brand of Philip Morris, the parent company), also received marketing permits for 4 new tobacco products and two mint-flavored disposable e-cigarettes through the pre-market application pathway. As of that day, NJOY LLC had received marketing permits for 10 new tobacco products, and SMOORE INTL supplied these 10 products to NJOY LLC.

The U.S. market is a significant source of revenue for SMOORE INTL. However, in terms of customer registration, revenue from the U.S. market in the first half of 2024 was 565 million yuan. It is worth noting that SMOORE's Hong Kong branch mainly engages in re-export trade, with most of the goods being shipped to the United States. According to its disclosure, the revenue from products sold from Hong Kong to the United States during the period amounted to 1.48 billion yuan, and the combined revenue from these two sources may reach 2.045 billion yuan, accounting for 40.60% of its total revenue.

It is foreseeable that with the regulatory approval obtained by its U.S. customers, SMOORE INTL's revenue from the U.S. is expected to rebound.

In addition, SMOORE's own brand business has shown strong growth, achieving a 71.94% increase in the first half of 2024, with revenue from Europe and other countries and regions growing by 88.0% annually. It is worth noting that the regulatory system in Europe has tightened during the review period. In this environment, SMOORE's own brand has still achieved strong growth, reflecting its significant growth potential in these markets in the future Where does SMOORE face challenges?

Nevertheless, SMOORE still faces significant challenges. With global regulatory tightening, its operating expenses are expanding. It needs to increase marketing investment to consolidate its market share. In the first half of 2024, SMOORE's marketing expenses increased by 79.49% year-on-year, accounting for 7.43% of revenue, up from 4.07% in the same period last year.

As mentioned earlier, SMOORE's research and development investment is also increasing, with a significant portion being allocated to unproven new areas such as beauty and healthcare. The cultivation of these areas may take time, so at least in the short term, the profit margin of its new businesses may be low or even result in losses.

This will drag down its overall profitability.

Therefore, SMOORE's biggest challenge may not lie in the recovery of its core electronic cigarette market, as this recovery seems to be underway. The problem lies in its future diversification strategy, which is likely to weigh on its overall profitability. This may be a concern for the market