On smoking ban and frugality campaign
Huabao sees no signs of the government cutting the cigarette output quota despite the recent high-profile anti-smoking campaign. Management expects China cigarette production to slow to 1-2% CAGR (c. 50m cases p.a. now) in the future, compared to 3-4% CAGR over the past 10 years.
Sales of cigarettes priced at RMB35/pack have decelerated amidst the central government’s frugality campaign, but the segment accounts for only 5% of total sales in China. Sales of mainstream products, i.e. RMB5-20/pack, are stable. Total cigarette sales volume declined 0.4% yoy in1H13, but increased by 1% in 11M13, implying recovery in 2H13.
On Reconstituted Tobacco Leaf (RTL)
According to Huabao, alternative materials like RTL fill only 5% of a cigarette in China, compared to 20-30% in rest of the world. The government has formed a team to promote use of RTL, and recommends filling up to 12% of a cigarette with RTL. Currently, total installed RTL capacity is 80k tonnes in China, and approved capacity is 170k tonnes. Based on China’s annual tobacco leaf consumption of 1.7m tonnes, and the government’s recommended usage, total demand would be 204k tonnes. Huabao’s current capacity is 30k tonnes, with an additional 10k tonnes under construction (through its 40%-owned RTL JV with Guizhou Tobacco).
RTL helps cigarette producers cut costs and lower tar content. The government requires all cigarette products to reduce tar content to 10mg by 2014 (from 11mg in 2013), and in the longer term, to around 8mg for leading brands. Due to a supply shortage, management expects an uptrend in the RTL price this year.
On future development
The company expects further consolidation of the industry, which should be favorable to large cigarette producers, i.e. Huabao’s major customers. It currently has one R&D center in Germany, and one in Shanghai. It will continue developing new products, eg. e-cigarette, and new alternative materials. It is also seeking opportunities to expand outside of China.