The focus of the latest update for RLX is the read-throughs from its contract manufacturer’s most recent quarterly financial performance. The Q3 2023 results of Smoore International (OTCPK:SMORF) (6969:HK), RLX Technology’s contract manufacturer, suggest that RLX’s sales might still be under pressure from competition posed by illegal products, while its profitability could be negatively impacted by an increase in R&D investments. As such, I stick with my existing Sell rating for RLX Technology.
Read-Throughs From Contract Manufacturer’s Q3 2023 Results
In RLX’s fiscal 2022 10-K filing, the company describes Smoore International as a key “contract manufacturer” for which RLX Technology’s “corresponding accounts and notes payable due to it (Smoore) represented 86% of our total accounts and notes payable” at the end of last year.
RLX’s third quarter financial results are scheduled to be announced in the middle of November, while details of Smoore’s Q3 2023 financial performance were previously disclosed in mid-October. Therefore, it is reasonable to think that Smoore’s recently revealed quarterly results offer valuable insights relating to the prediction of RLX Technology’s Q3 performance.
As indicated in its Q3 2023 financial results announcement, Smoore’s top line and earnings before tax decreased by -10.3% and -36.3% to RMB2,879.3 million and RMB526.4 million, respectively, in the most recent quarter.
Smoore’s poor financial performance for the third quarter of this year seems to be consistent with the changes in the sell side’s consensus financial projections for RLX Technology. In the past three months, three of the four analysts covering RLX shares lowered their full-year fiscal 2023 normalized earnings per share or EPS estimates for the company. In specific terms, RLX Technology’s consensus FY 2023 bottom line forecast was cut by a substantial -35.7% during the same time period.
It is fair to say that the market thinks that RLX Technology’s financial performance will be lackluster for the remainder of 2023, and this bearish view of RLX’s results appears to be validated by Smoore’s disappointing third-quarter results.
Illegal Products A Competitive Threat In The Mainland Chinese Market
Smoore stressed in its Q3 earnings announcement that the “year-on-year decrease of 85.6% of revenue from the Mainland China market” was the major reason for its -10.3% YoY top-line contraction for the recent quarter.
RLX Technology had mentioned in its FY 2022 20-F filing that the company’s sales are almost entirely generated from Mainland China. As such, the weak quarterly revenue performance of RLX’s contract manufacturer in the China region is bad news.
At its earlier investor call in August this year, RLX emphasized that “China’s compliant e-vapor brands are losing market share to illegal flavored products” and noted that “the presence (of such illegal offerings) in the (Chinese) market will impede our recovery in the short term.”
RLX Technology also guided at the August 2023 investor briefing that “our sales will continue to grow sequentially if illegal product sales are not worsening.” This suggests that RLX’s revenue might continue to decline YoY (versus QoQ growth) in the quarters ahead as per the base case scenario of stable illegal product sales. The sharp -85.6% plunge in Mainland Chinese market revenue for Smoore, RLX Technology’s contract manufacturer, sends negative signals about RLX’s top-line performance for the very near term.
Smoore mentioned in its most recent quarterly financial results release that its overall costs grew by +30.1% YoY in Q3 2023. Smoore specifically highlighted that “research and development (R&D) expenses” were one of the cost items that saw a meaningful increase for the third quarter of the year.
I am of the opinion that RLX Technology’s R&D costs might also rise significantly, just like what its contract manufacturer witnessed in the recent quarter.
To remain competitive with illegal products in China, it is realistic to think that RLX will have to invest a lot more in R&D. As an example, RLX Technology expanded the number of flavors for the company’s products from eight at the end of last year to 14 by the middle of this year as outlined at its August investor call. Looking forward, RLX will likely be investing more in R&D to develop a wider range of flavors for its product offerings, improve the quality of existing products, and develop new and innovative offerings.
This means that there could be downside risks associated with RLX Technology’s future profitability, in the event that the company’s actual R&D costs turn out to be much more significant than expected.
I retain a Sell rating for RLX Technology. The recent quarterly financial performance for RLX’s key contract manufacturer (Smoore) was poor, and this indicates that RLX Technology is unlikely to achieve a decent set of financial results in the short term.
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