RLX Technology: A Potential Miss For Upcoming Results (NYSE:RLX)

Elevator Pitch

I assign a Sell investment rating to RLX Technology Inc. (NYSE:RLX) shares.

In my earlier May 26, 2023 initiation article, I did a review of RLX’s financial results for the first quarter of this year. For the current update, my attention turns to previewing RLX Technology’s Q2 2023 financial performance.

My analysis leads me to the conclusion that RLX’s second quarter results might be a miss, and this could lead to a decline in RLX Technology’s stock price post-earnings announcement. Therefore, I have decided to downgrade my rating for RLX from a Hold previously to a Sell now.

The Sell-Side’s Expectations Of RLX’s Second Quarter Performance

RLX Technology is expected to release its Q2 2023 results on Friday, Aug. 18, 2023 before trading hours.

Analysts think that RLX would have performed better on a QoQ basis in the second quarter of 2023 as per the consensus financial forecasts taken from S&P Capital IQ.

In specific terms, the market estimates that RLX Technology will report a Q2 2023 revenue of RMB346 million, which implies that RLX’s YoY top line drop will improve from -89% YoY in Q1 2023 to -85% YoY for the recent quarter. This also is equivalent to a +83% QoQ growth in RLX Technology’s sales in Q2 2023. Separately, RLX’s normalized operating loss is projected to be -RMB81 million for Q2 2023, and this will represent an improvement in profitability as compared to its -RMB133 million operating loss in the first quarter of 2023.

In my opinion, the sell-side analysts are far too optimistic about RLX Technology’s performance in the second quarter of the current year, as I would explain in the next section.

My Prediction Is A Q2 Results Miss For RLX Technology

I take the view that investors could be disappointed when RLX Technology announces its second quarter results in the later part of this month.

As it relates to RLX’s Q2 top line performance, there are negative read-throughs from its contract manufacturer’s financial guidance and its own management commentary.

Shenzhen Smoore Technology, a subsidiary of Smoore International (OTCPK:SMORF) (OTCPK:SMHRY) [6969:HK], is RLX’s key “third-party operational partner of our (RLX’s) exclusive production plants” which represented more than three quarters of RLX Technology’s purchases for both 2020 and 2021 as indicated in its 20-F filing. In the middle of last month, Smoore International issued an announcement disclosing its expectations of a 43.1%-48.4% contraction in its normalized earnings for 1H 2023. Smoore International highlighted in its announcement that the weakness in the Mainland Chinese market was the main reason for the sharp drop in its expected first half net income, and RLX Technology generates all of its sales from China. As such, it’s reasonable to assume that RLX’s 1H 2023 revenue performance might be poor.

At the company’s Q1 2023 results briefing on May 17, RLX cautioned that there are “uncertainties” associated with its full-year performance, considering that “the overall user sentiment hasn’t fully recovered yet.” I also highlighted in my late May 2023 initiation article that there have been adverse regulatory developments for the Chinese e-cigarette market in recent times like the new “excise tax for e-cigarettes” and the ban on “flavored e-cigarettes.” It won’t be a surprise if RLX Technology’s actual sales come in below expectations due to weak consumer demand and policy headwinds.

In terms of the company’s profitability, the downward revision in RLX Technology’s full-year EBIT forecast in recent months appears to be justified.

As per S&P Capital IQ’s financial data, the sell-side analysts’ consensus FY 2023 EBIT estimate for RLX Technology was lowered by -4% in the past three months to RMB198 million as of Aug. 3. I think this is fair, taking into account negative operating leverage and the lower-than-expected revenue contribution from higher-margin new products.

RLX Technology acknowledged on its first quarter results call that the company is affected by the “deleveraging effect of reduced sales” which had a “low single-digit percentage” hit on its Q1 gross profit margin. Given that I expect RLX’s Q2 2023 sales to fall short of the market’s expectations, RLX’s profitability is likely to still be impacted by negative operating leverage, in my opinion.

Also, it could take a longer than expected time for RLX to tweak its sales mix to boost its profit margins. At its Q1 earnings briefing, RLX Technology stressed that it “will definitely share more color with you (analysts and investors) when they (new higher-margin products) can contribute a meaningful financial contribution.”

RLX’s Valuations Are Still Demanding

RLX Technology is currently valued by the market at a very demanding consensus forward next twelve months’ price-to-sales multiple of 7.9 times (source: S&P Capital IQ).

The sell-side analysts are of the view that RLX’s top line contraction will worsen from -37% in FY 2022 to -57% for FY 2023 as per S&P Capital IQ data. As mentioned in the prior section of this article, I expect RLX Technology’s Q2 2023 results to be a disappointment for the market.

As such, I think that there is the potential for a de-rating of RLX price-to-sales multiple in time to come, which translates to further downside for the company’s share price.

Concluding Thoughts

A potential Q2 2023 results miss could be the catalyst for a decline in RLX Technology’s stock price in the later part of August, in my opinion. This explains why I have chosen to rate RLX’s shares as a Sell.