Smoore International FY2023 results - key takeaways

BTI 0.00%↑ PM 0.00%↑

I just attended the results announcement event of Smoore International this morning and want to share a few relevant updates that may interest investors of BAT and PM. Smoore has long been the ODM supplier (de facto exclusive supplier) of pod-based vaping device and cartridge to major tobacco companies and independent vaping brands such as BAT (Vuse Alto), Japan Tobacco (Logic), Njoy (now owned by Altria) and RLX Technology (PRC) / RELX Inc. (ex-PRC), and more recently the supplier of disposable vaping device to BAT (Vuse Go). Over the past 5 years, the industry landscape of e-vapor has undergone seismic shift due to regulatory headwind, proliferation of illicit products and lack of enforcement. While investors assess the current status based on results announcement of major tobacco companies and monthly update from Nielsen data (for U.S. market), I think it is helpful to look at the situation through the lens of their key supplier in China. Here we go.

1. Smoore International’s role as an ODM supplier to BAT, given BAT’s establishment of “Innovation Center” in Shenzhen, China.

   1. The “Innovation Center” in Shenzhen is basically a supply chain management arm, primarily responsible for sourcing of raw materials and components. It is more like an office rather than a fully fledged laboratory.

   2. The Innovation Center allows Smoore to work more closely with BAT in Shenzhen and they work side by side everyday. Their collaboration model remains the same - meaning Smoore will continue to focus on product R&D, while BAT will take care of sales, marketing, distribution, regulatory approval etc.

2. Smoore International’s HNB strategy to compete with PMI.

   1. They recognise the >US$10bn investment made by PMI thus far in the HNB category, but still believe that Smoore can be more effective in R&D to develop a differentiated product. As always, Smoore will partner with its major tobacco customers to jointly develop the product instead of going solo.

   2. They are partnering with their major customers in product development, but can’t disclose too much due to confidentiality and the product still in multi-year validation phase.

   3. There are still pain points to be addressed, such as pre-heating time required (20 seconds for IQOS Iluma) and ability to deliver consistent taste from the first puff till the last puff.

   4. In terms of market segmentation, it is up to Smoore’s customer to decide whether they want to target the high end or below weighted average price (WAP) market. Smoore will focus on product differentiation and science.

3. Smoore International’s disposable vape strategy.

   1. While Smoore recognised they were a bit late to this category due to lack of market vision, it is not entirely their fault as it is their customer’s responsibility to take care of sales and marketing and provide timely feedback on customer preference changes. Given their role as an ODM supplier, even in hindsight there’s not much they could have done to accelerate their entry into this product category.

   2. While they recognise their major competitor, iMiracle’s strength in supply chain management, quality assurance and innovation that contribute to their leading market shares in the U.S. and Europe, Smoore is stronger in terms of regulatory compliance and presence in strategic channels (e.g. convenience stores).

   3. Should Europe impose ban on disposable vape, they could see a strong uptick of pod-based vaping volume, which will be margin accretive. But this won’t happen in 2024, as implementation of new regulation takes at least one year in many EU jurisdictions. Smoore will not bet on the outcome and will get prepared for either scenario to remain relevant in the marketplace.

4. Smoore International’s pod-based vaping strategy.

   1. A few years ago, there used to be some critical pain points of pod-based vaping products, such as battery explosion, leakage of e-liquid and quality of vapor. Smoore became the dominant market leader in pod-based vaping ODM due to its patented technology that offers the best-in-class products. However, there may not be further room for innovation as competing products are catching up fast.

   2. For example, disposable vape products have addressed all these pain points well and deliver even better user experience due to convenience and customer acceptance.

To summarise the above feedback by Smoore International, my take is that for the partnership between BAT and Smoore to be successful, one key element is that BAT needs to react faster to the market change and be “proactive” in some areas. I think that resonates with BAT CEO’s vision that they still adhere to the same strategy but need to improve sharpness in execution. Over the past 100 years, there’s not much major innovation in the cigarette product itself other than cigarette filter in mid 20th century and flavor capsule in early 2000’s. Tobacco companies are not built to embrace product innovation. What happened during the past 5 years should have taught BAT a lesson.

However, it is easier said than done. Here is an example, which is a Reynolds American employee feedback I found on Glassdoor. I have monitored Reynolds American employee feedback regularly since the U.S. business showed weakness towards the end of 2022. Such feedback is not a standalone case.

Mar 14, 2024

Great Company plagued by quite a few arrogant & complacent individuals

Anonymous- Salaried Staff

Former Employee, more than 1 year

Winston-Salem, NC

Pros

Great Benefits, Good Value system, Has the potential to attract Top talent across the country.

Cons

1) Quite a few Arrogant and complacent old timers who have become comfortable and are resistant to change. Ideally want to maintain status quo till they retire or company offers them a package 2) Growth for young talent is limited due to the issue above 3) Poor age demographics leading to bright young talent choosing more upbeat & progressive workplaces 4) While the company aspires to be Inclusive. few of the folks ( mainly directors / senior directors and above ) are destructive & toxic

Advice to Management

The organization has good values, but they should be followed. People who are only working for a package or retirement should be addressed, so that they don't block more innovative ideas that suit the evolving industry. If some want to maintain the status quo, that's okay, but these people should’t be allowed to hinder people who are trying to do the best things for the organization. These individuals prevent the talent growth pipeline. I hope the management can solve that and I will be glad to re apply for a position

As an investor, we are often concerned about how the management address different issues and then assess the management execution quality by comparing financial results delivery against guidance and competitors’ performance. However, from the company CEO’s perspective, a greater question to ask is how they can build a company that can better adapt to changes in general. New market, new product category, new regulation and new competitor can emerge anytime beyond planning or imagination. It is the capability to survive and thrive amid the changing environment that defines a great company. Think about American Express who began as a freight forwarding company in 1850, then transformed itself to cards to innovative digital products and services. Their capability to evolve is a much greater asset than their market leadership in whatever segment that they operate in.

While I intend to invest in BAT over the long term, I keep reminding myself that I need to put my shoes into its CEO and Board of Directors so as not to lose sight of the bigger picture.