- Following the World No Tobacco Day 2013 launch over the weekend, the Health Ministry, under the purview of a new health minister, Datuk Seri Dr S. Subramaniam, underlined its tough stance against smoking by announcing several initiatives to further discourage smoking among Malaysian consumers.

- According to news articles in various local dailies, the measures it will undertake include: -

1) Gradually reducing the maximum allowable nicotine and tar levels in cigarette sticks over two phases by 33% and 50%, respectively. Phase 1 (by January 2014) will see nicotine content fall from 20mg/stick to 15mg/stick while tar levels will decline to 1.25mg/stick from 1.5mg/stick. In the second phase (by June 2015), nicotine and tar content should reach the targeted 10mg/stick and 1mg/stick levels. While we note that the timeframe had been pushed back from its previous guidance of September 2013 and 2014 respectively, it still falls short of the tobacco manufacturers’ request for a 2018 timeline to meet the final target;

2) Introduction of new images as pictorial health warnings (PHW) and a size increase of 10% to 50:50, from 60:40 currently. In a nod towards the possible adoption of the plain packaging model, the ministry said it will review whether cigarette packs at convenience stores represent an indirect form of brand promotion. Nonetheless, we believe the authorities will wait to take the cue from Australia over the legality and effectiveness of doing so;

3) Expansion of designated no-smoking areas to include all roofed-areas (e.g. covered walkways);

4) Prohibition of cigarette discounts to customers; and

5) Reviewing direct and indirect promotional activities by the tobacco manufacturers. This includes regulating their sponsorship activities and CSR programmes as well as evaluating the display of cigarettes in convenience stores. Anecdotal evidence from a similar implementation of the latter in England shows that keeping the products hidden helped 17% of all smokers reduce the amount they smoked and aided 25% of 18 to 24-year olds in quitting;

- These reforms are in line with Malaysia’s bid to comply with WHO’s Framework Convention on Tobacco Control (FCTC), of which it has been a signatory since 2003. The main provisions of the FCTC include a reduction in the demand (eg. price and tax measures, tobacco advertising, promotion and sponsorship) and supply (eg. illicit trade, sales to and by minors) of tobacco.

- We are negative on these proposed regulations as we believe these moves will exert further downward pressure on already apathetic legitimate industry volumes. No adjustments to legal TIV growth have been made at this juncture pending further concrete developments. However, do note that we have recently revised downwards our FY13FFY15F legitimate TIV growth assumption to 0%-1% following BAT’s announcement of a 3% hike in cigarette prices across its brands. Surprisingly, its peers, JTI and PMI, have reportedly declined to follow suit. Other threats to legal volumes could come from a probable hike in excise duties as the government’s spending is set to rise after the 13^th general election.

- Looking ahead, we reckon that tobacco manufacturers will face greater difficulty in controlling their costs as additional price hikes could lead to greater downtrading activities, especially for the more price-sensitive VFM segment brands. This will only serve to benefit the already high illicit volumes (FY12: 34.5%) and intensify the proliferation of cigarettes sold below the minimum price of RM7.00/pack.

- We maintain our NEUTRAL recommendation on the tobacco industry with HOLD recommendations on both BAT (FV:RM62.00/share) and JTI (RM7.20/share). Dividend yields for the stocks are fairly decent at 4.4% for BAT and 5% for JTI.

Source: AmeSecurities