-  A local daily recently reported that contraband cigarettes are enjoying brisk sales, thanks in part to their ease of availability. While these illicit sticks are openly sold in the city centre, we understand that vendors in the suburbs are more cautious, hiding the packs under newspapers or behind the counter and only offering them to regular customers.

-  The illicit sticks are typically smuggled into the country through easily accessible entry points along the coastal areas. Most of them originate from Indonesia, Vietnam, Cambodia and Myanmar.

-  We gather that there are close to 130 types of illegal cigarette brands in the market, with the most popular being Gudang Garam, John International, Nusantara Kretek and Canyon. The brand names often have a short lifespan in order to avoid easy detection by custom officials.

-  These contraband cigarettes cost between RM3.00 and RM3.50 per pack - roughly a quarter of the price of a duty-paid 20s pack. A 50 sen discount per pack is also reportedly given to customers who buy 20 or 30 packs in bulk. The cigarettes are available in packs of 12s and 20s.

-  According to one vendor, sales have increased by four- to five-fold. Illicit sticks, at the last count in May, made up 33.6% of the total cigarette market.

-  We are not surprised by this as we believe that local smokers - who are feeling the pinch due to constant price hikes of duty-paid cigarettes (three times in the past year alone) and declining disposable income - are switching to illicit sticks in greater numbers. Previously, illicit sticks were only smoked by foreign workers, mainly those in the construction sector.

-  The rise of illicit cigarettes is a headache for the government. Besides the obvious loss in government revenue, the proliferation of illicit sticks may increase health problems and further strain the healthcare budget. As it is, the cost of treating chronic diseases related to smoking is RM3.8bil while the average annual revenue earned by the government from cigarette tax is RM3bil.

-  Recognising this, the government has proposed several laws to combat the illicit trade, including mandatory imprisonment for those dealing in illegal cigarettes as well as stricter and swifter enforcement.

-  We maintain our NEUTRAL stance on the sector with HOLDs on BAT (FV:RM62.00/share) and JTI (FV:RM7.20/share) at this juncture. While we foresee a spike in illicit volumes in the coming months following the sharp RM1.50 hike in pack prices in October, we believe the price increase is more than sufficient to offset any loss in legal volumes, thus ensuring the tobacco manufacturers’ margins remain intact.

Source: Kenanga