- At its AGM yesterday, British American Tobacco (M) Bhd’s (BAT) management reiterated its concern over the high level of illicit cigarettes in the domestic market.

- The “Illicit Cigarette Study” revealed that the market share of illicit sticks had grown by 1.2ppts from 34.5% in 2012 to 35.7% in 2013. This included a spike to a record 38.9% in 4QFY13 following the announcement of a steep 14% hike in excise duty in September 2013.

- The rise in illicit cigarette volume came at the expense of the legal industry’s volume. Legitimate industry volume had declined by 6% YoY in 2013. The fall was greater in the fourth quarter, at 17%. This had more than offset the rise in excise duties, as indicated by the government’s lower collection on excise and duty from the tobacco manufacturers in 2013.

- That said, we understand that efforts to curb the illicit trade has been rising, too. The government had recently amended the Control of Tobacco Product Regulations 2004 to target those in the illicit trade. Management had also acknowledged the increased efforts of the enforcement officers.

- In view of the rapid growth of illicit sticks, management believes that downtrading by smokers to the aspirational premium segment is less of a threat compared to the switch from legal to illicit cigarettes. As it is, illicit sticks are priced more attractively (at only RM3.50/pack vs. premiums’ RM12.00/20s pack). Aspirational premiums are sold at RM10.50/pack, a 12.5% discount to premiums.

- That said, we note that the premium segment has remained fairly resilient. Its share of market had expanded by 1.2ppts to make up 74% of the legal industry’s volumes. This uptrend bodes well for BAT, whose stronghold lies in this segment.

- Looking ahead, management is confident that it will be able to maintain a decent earnings growth for FY14F (FY13:+3%). To achieve this, the group is aiming to further rationalise its costs (FY13: -7.7%). Margins could also potentially expand with the group now procuring its tobacco leaf from overseas as imported leaves may be up to 30% cheaper.

- No change to our forecast at this juncture. We maintain our HOLD recommendation on BAT with an unchanged fair value of RM62.00/share. 

Source: AmeSecurities