- We reaffirm our HOLD recommendation on British American Tobacco (BAT), but with a higher DCF-based fair value of RM62.00/share (from RM56.60/share) as we roll forward our valuation year to FY14F.

- Yesterday, BAT announced that it will raise the prices of all its cigarette brands by 30 sen per pack effective today. This represents an increase of 3%, which management attributes to the rise in operating expenses as a result of inflationary pressures as well as higher labour and raw material costs.

- Following this, the retail selling prices for its value-for-money (VFM) brands, namely Pall Mall and Peter Stuyvesant, will be RM9.00/pack while its premium labels including flagship brand, Dunhill, will be sold at RM10.50/share.

- Based on previous price adjustments, we believe the other manufacturers JT International (JTI) and Philip Morris International (PMI) will follow suit.

- Despite anticipating a price jump this year, we are nonetheless slightly surprised at its timing and quantum. The last price increase of 20 sen/pack (which came after a government-directed hike in ex-factory) was rather recent (October 2012). That, however, came about after a 2-year hiatus.

- We note that a rise in ASP is detrimental to legitimate industry volume growth (FY12: +6%) as it will only spur the sales of illicits, specifically the illicit whites (FY12: +0.9ppt YoY to 23.6%) and exacerbate the proliferation of cigarettes sold below the minimum price of RM7.00/pack.

- To put things into perspective, the previous price rise had resulted in sliding QoQ volumes for BAT. In 4QFY12, its volumes were down 5% and in 1QFY13, a further 3%. We have thus lowered our FY13F-FY14F legal TIV growth assumption to 0% from 2%, previously.

- The rapidly shrinking legal TIV pie would be a major constraint to earnings growth for the tobacco manufacturers. Coupled with the firm stance by the Health Ministry to further tighten tobacco control, the outlook for the sector remains challenging.

- The ministry had recently reiterated its long-term policy against smoking, underlining its commitment to WHO’s Framework Convention on Tobacco Control (FCTC) by introducing various new measures and follow-through of prior announced changes (eg. the reduction in nicotine and tar level to 10mg and 1mg respectively by 2015 and the larger pictorial health warnings on face packs to 50%).  

Source: AmeSecurities