Huaan: Tobacco consumption has strong counter-cyclical characteristics, while there is still room to increase taxes on electronic cigarette consumption.

Huaan released a research report stating that the brand development of China Tobacco follows the main theme of "brand as the core, specifications as the guidelines, and structure as the foundation". In recent years, there has been optimization and reduction of brand specifications, with a focus on the continuous development of key brands. It is worth noting that from a consumer perspective, tobacco consumption demand is rigid and has strong countercyclical properties. In the context of tobacco control, cigarette sales growth is limited, mainly driven by continuous product structure upgrades to increase prices and thereby drive market size growth. Looking at electronic cigarettes, in the background of declining cigarette market, electronic cigarettes provide market growth, and electronic cigarette taxes will also provide additional revenue for the national tax. In China, electronic cigarettes are subject to ad valorem consumption tax at the production and wholesale levels. Compared to traditional cigarettes, there is still room for increases in the consumption tax on electronic cigarettes. Huaan's main points are as follows: Taste and health spiral, price increase drives market growth From a historical perspective, tobacco, as an addictive consumer product, shares similarities with various food products, revolving around the twin themes of "health" and "taste", with technology and products serving as drivers of development. Globally, the early tobacco systems were primarily monopoly systems, which later evolved into a balance between government interests and international pressures, categorized into fully monopolized, partially monopolized, regulated competitive, and free competitive systems. In terms of market size, in 2023, global tobacco sales amounted to USD 927.4 billion, with cigarettes accounting for 82.3% of tobacco products, while new tobacco products are experiencing rapid growth. Despite declining smoking rates, high prices, new products, and new markets will continue to drive the stable development of the global tobacco market. One organization, two brands, China Tobacco monopoly In terms of organizational structure, the Chinese tobacco industry implements a unified leadership, vertical management, and monopoly system, where China Tobacco is responsible for the unified management and comprehensive operation of the tobacco industry, including production, supply, distribution, personnel, finance, domestic and foreign trade, with an ROE of around 12% and a net profit margin of around 15%. Looking at the industry chain, the tobacco industry chain consists of tobacco planting, tobacco purchase and sale, tobacco processing and cigarette manufacturing, cigarette wholesale, and cigarette retail, all of which are developed under the leadership of China Tobacco. In terms of brands, China Tobacco's brand development follows the main theme of "brand as the core, specifications as the guidelines, and structure as the foundation", with recent years focusing on optimizing and reducing brand specifications, and continued development of key brands. In terms of tender procurement, the scope of tobacco materials procurement is wide, with A-share companies mainly involved in packaging aspects such as cigarette labels, cigarette wrapping paper, and cigarette paper. Tobacco consumption shows strong countercyclical characteristics, making a significant contribution to government revenues Looking at consumption attributes, tobacco consumption demand is rigid and exhibits strong countercyclical properties. In recent years, under the backdrop of tobacco control, cigarette sales growth has been limited, mainly driven by continuous product structure upgrades to increase prices and thereby drive market size growth. The performances of the four major multinational tobacco companies are stable, operating across cycles, with stable EPS growth and a high dividend payout ratio driving the market value of tobacco companies. In terms of contribution to government revenues, China Tobacco's annual contribution to the total fiscal revenue is around 7%, and the tobacco consumption tax accounts for approximately 51% of total consumption tax revenue, making it the most important component of consumption tax. However, compared to global countries, there is still room for increasing tobacco taxes in China, and there is still room for improvement in the proportion of revenue allocated to local governments. Looking at electronic cigarettes, in the background of declining cigarette market, electronic cigarettes provide market growth, and electronic cigarette taxes will also provide additional revenue for the national tax. In China, electronic cigarettes are subject to ad valorem consumption tax at the production and wholesale levels. Compared to traditional cigarettes, there is still room for increasing the consumption tax on electronic cigarettes. Starting from individual smokers, looking at consumer profiles In recent years, under the continuous implementation of tobacco control measures in China, the smoking rate among Chinese adults has decreased from 27.5% in 2009 to 24.4% in 2023; the number of adult smokers has decreased from 278 million in 2009 to 276 million in 2023, with a -0.05% compound annual growth rate (CAGR). Although the number of smokers has decreased, the consumption volume and expenditure of smokers have continued to increase. The per capita consumption volume of adult smokers has increased from 8,008 cigarettes per year in 2009 to 8,839 cigarettes per year in 2023, with a CAGR of 0.71%; and the per capita expenditure of adult smokers has increased from RMB 2,963 per year in 2009 to RMB 6,575 per year in 2023, with a CAGR of 5.86%. In recent years, the affordability of cigarette consumption has continued to increase, and Chinese smokers have a high capacity to pay for cigarettes. Cigarette consumers show high brand loyalty, with price and taste being important factors influencing brand choice. Risk warning Industry regulatory policy risks. The tobacco industry is subject to strict government regulations, and the implementation of new laws and regulations, increased enforcement by regulatory agencies, and changes in policy orientation may have a significant impact on the development of the tobacco industry. Supply chain share change risks. The stability of the supply chain is influenced by changes in market demand, the coordination of various links in the supply chain, and external environmental factors. If there are problems such as inventory backlog, overcapacity, or supply shortages in the supply chain, it may lead to changes in supply chain shares, affecting the profitability and market competitiveness of enterprises. Risk of data sourcing. The quality of data, reliability of data sources, and accuracy of data processing cited in the report are difficult to trace, which may lead to inaccuracies, incompleteness, or outdated information in the cited data, thereby affecting the effectiveness and accuracy of the opinions. Slow progress in new product expansion. If the progress of new product development and new business expansion in the tobacco industry falls below expectations, it may have a negative impact on the future growth of the industry and companies. Risk of financial and tax policy changes. Changes in financial and tax policies may include but are not limited to adjustments in tax rates, changes in tax incentives, and alterations in tax management methods. Changes in financial and tax policies will directly affect the tax burden and compliance of the tobacco industry. Price adjustment risks. Price adjustments may affect consumer purchasing decisions, leading to fluctuations in demand. Price adjustments will have an impact on long-term profits, market share, and brand reputation.