China Tobacco’s Overseas Unit Goes Public

Features

By Tobacco China Online

China Tobacco International (HK) Co. (hereinafter referred to as CTI), the overseas subsidiary of China National Tobacco Corporation (CNTC), saw wild trading days with a strong rise, sudden fall, or crazy pullback since it went public in Hong Kong on June 12, 2019. It surged nearly 500% within just a dozen of trading days. Investors have been drawn in because of the scarcity of listed assets in China’s massive cigarette market.

CTI’s primary business

Established in 2004 and headquartered in Hong Kong, CTI is responsible for capital operations and is the only international business development platform for CNTC. It primarily procures tobacco leat from countries like Brazil, Argentina, and Canada for its parent company, and exports tobacco produced by Chinese farmers to Indonesia, Thailand, Singapore, etc. The international unit is also the sole exporter of Chinese cigarette brands like ChungHwa, Yuxi, Hongtashan, and Baisha to duty-free outlets in other countries and regions. In May last year, it began exporting heat-not-burn (HNB) tobacco products made in China.

HNB’s market potential

The overseas HNB market has risen rapidly in recent years, providing alternatives to conventional smoking. For instance, Philip Morris International (PMI) has achieved a huge preemptive advantage in the industry with IQOS, the world’s first HNB product. Its market share in Japan has rapidly increased from less than 1% in the beginning to 16.9% as of the first quarter of 2019; and currently, 70% of IQOS consumers are those who switched from other competitors’ cigarette brands. The HNB segment has already risen to be an essential part for tobacco companies to win over consumers. By the end of 2018, the HNB retention rate in Japan exceeded 40%, which demonstrates that this market segment is huge.

According to statistics from the World Health Organization, the popularity of vaping, e-cigarettes, and HNB tobacco products reached 2.26% in 2017 with an obvious upward trend, but the penetration rate of new tobacco products in China was only 0.27%., far below the world average level. However, CNTC has already carried out a more extensive and in-depth plan in this great potential segment.

In October 2017, China Tobacco (Sichuan)Industrial Co. Ltd. entered the South Korean market with its HNB product named Kung Fuas as well as the pod named Kuanzhai, China’s first overseas-listed HNB brand. In 2018, China Tobacco Guangdong’s first batch of HNB tobacco products MU+ were available in Laos. In October 2018, China Tobacco Anhui held the world premiere ceremony for its HNB product of magnetic particle soaking technology in Hefei, the capital city of Anhui province. One month later, China Tobacco Hubei held a press conference to launch its HNB product – MOK. China Tobacco Shandong, China Tobacco Guizhou, and others are also now undergoing r&d for HNB products.

In May 2018, CTI began to exclusively export new tobacco products for its parent company to the global market, mainly HNB tobacco products to Asia. According to data from CTI’s prospectus, the average export price of HNB products in 2018 was about HK$360 per thousand sticks, which have been increasingly recognized in the international market. Since CNTC invested a large amount of effort in r&d, the average export price may rise in the future. According to the forecast of China Merchants Securities, the annual market capacity of new tobacco is supposed to be RMB58.5 billion, assuming the switch rate and the price of a single pack of pods are 5% and RMB10  respectively, and RMB226.5 billion with 10% and RMB20/bag. The market potential is very promising.

CTI’s promising future

As the only international business platform of CNTC, CTI is expected to expand its business to overseas markets and the new tobacco products segment, committed to be the leader of CNTC in integrating overseas resources, and a direct beneficiary in the development and transformation process of China’s tobacco industry. Known as the “First Tobacco Stock” in the Hong Kong stock market, the international unit is attractive to retail investors since it is of strong scarcity and its business model is easy to understand, which may be one of the important reasons for the company’s stocks attractiveness.

Another important reason is the huge domestic market behind it. CTI actually represents only a very small part of CNTC’s overall business, of which the domestic cigarette market share is bigger than the total of such big companies as Philip Morris International, British American Tobacco, Japan Tobacco, Imperial Brands, and KT&G in the world. With 306 million smokers in China in 2018, CTI’s cigarette sales reached RMB1.44 trillion, accounting for 44.6% of global cigarette consumption. The large population of smokers enables a stable market for tobacco leaf imports, one of the four business segments of the international unit. Jeffrey Chan Lap-tak, co-founder of Oriental Patron Financial Group, also raised another reason why CTI has been favored by capitals, “The market liquidity is now sufficient as there is no equivalent IPO in the Hong Kong market.”

On the journey to internationalization

The combination of a slowing domestic economy and efforts by health officials to curb smoking in a country where over a quarter of the adult population are regular users means CNTC is now taking aim at western rivals in global markets. For instance, the Advertising Law, which was first revised in 2015, bans tobacco advertising in mass media, public venues, public transport, and outdoor, as well as banning any form of tobacco advertising to minors. All kinds of measures have led to a continuous decline in the number of smokers, weakening the advantage of implementing a tobacco monopoly system in China. According to customs data, the value of China’s cigarette exports in 2018 was US$722 million, up from US$248 million a decade ago, most of which were developing countries in Asia. The Chinese government backs CNTC’s global push, comprehensively enhancing its global competitiveness with its own leading brands in the world. CNTC has established subsidiaries in Argentina, Namibia, and the UAE, and has set up a joint venture with PMI in Switzerland to distribute Chinese cigarette brands in Europe with the goal of exporting 400 billion cigarettes by 2020.

In 2018, PMI’s cigarette sales reached 15.964 million boxes, BAT 13.725 million boxes, Japan Tobacco 9.828 million boxes, and Imperial Brands 5.304 million boxes. CNTC sold 47.52 million boxes of cigarettes in 2018, more than the sum of the top four tobacco giants. However, it basically sold the cigarettes in the domestic market since the proportion of cigarette exports accounted for only about 3% of its total tobacco revenue.

Given the current situation, CNTC still remains in the primary stage of internationalization, and CTI has been tasked to go global on behalf of CNTC. The global push in HK is expected to expand sales channels in Southeast Asia and other major target markets as well as strategic cooperation with other international cigarette makers. The year-long US-China trade war has had a major impact on CTI’s business. The company has not procured any tobacco from the US since July 2018 when the two countries began to impose tariffs on their respective goods, decreasing from about 30% of tobacco leat imported from the US each year. However, the market sentiment has improved by the end of this past June when the Chinese president Xi Jinping and his US counterpart, decided at the G20 meeting to resume talks. As such, the market performance in the future may be positive as this move indicates that the external crisis factors have been alleviated.