- In an interview with The Edge Financial Daily, JTI’s management said that sales volume for the legitimate industry had declined by 10% in 4QFY13. While the bulk of the fall can be attributed to the 3sen/stick (+14%) hike in tobacco excise duty announced by the government on 27 September 2013, we do not rule out pre-budget stockpiling activities in 3QFY13 (although comparatively mild when compared to previous years) as having played a part.

- We are not surprised by this news as a double-digit drop in legal total industry volumes for FY13FFY14F had been widely anticipated in view of the steep hike in excise. Although cigarette demand is widely considered to be inelastic, the presence of illicit sticks (~35% share of market) and ELPCs (4.2% share of market) have made duty-paid cigarettes more elastic than imagined.

- Management admits that VFM brands are more susceptible to downtrading activities vis-a-vis the premium brands. Given its dominant position in the former, (>50% market share through its Winston brand) the group will be able to offset any loss in market share through downtrades within the legal market.

- We concur with management’s view that it will be able to generate the same profit margins as before. We suppose that JTI had taken cues from the previous price hikes (which were deemed inadequate in hindsight) to adjust its prices in Oct. The most recent price hike saw a price increase to excise increase ratio of 2.5x vs.1.3x historically.

- In a bid to combat the slide in legal volumes, management is focusing on product innovations and stepping up its marketing activities. The group had recently launched Mevius Airstream which provides smokers a fresh smoking experience by delivering the smoke differently.

- Meanwhile, we learned that JTI has no plans to enter the e-cigarette market at present. Cheaper illicit sticks have become a more viable alternative for some smokers resulting in a relatively low penetration of e-cigarettes in the domestic market.

- The rapidly shrinking legal TIV pie would be a major constraint on earnings growth for the tobacco manufacturers. Nonetheless, we believe that the stock will continue to be of interest to income investors as well as those who seek defensive attributes in their equity holdings. JTI’s FY13F-FY15F yields, which are on an average of 5.2%, are fairly attractive still.

- We are keeping our current forecasts and HOLD rating for now pending the release of its FY13 results on 20 February 2014. Our DCF-derived fair value for the group remains unchanged at RM7.20/share.

Source: AmeSecurities