- We maintain our HOLD recommendation on British American Tobacco (M) (BAT) with an unchanged DCF-based fair value of RM66.30/share.

- In a press statement yesterday, BAT announced that it has reversed its decision to raise the prices of all its cigarette brands by RM1.00/pack of 20s (+8.5% to +9.5%), which was made two weeks ago on 8 Sept 2014.

- The turnaround means that retail selling prices (RSP) of its aspirational premium (VFM) brands, namely Pall Mall and Peter Stuyvesant, will revert to RM10.50/pack while its premium and flagship label Dunhill will be sold at RM12.00/pack. These prices were effective yesterday.

- BAT had earlier said that it needed to raise the prices of its cigarettes to counter rising operating expenses (i.e. higher production and distribution costs), which resulted from inflationary pressures.

- The tobacco manufacturers are known to be quick in passing on any additional costs and tax hikes to consumers. In view of the oligopolistic nature of the industry, price adjustments by the “Big 3” domestic players, i.e. BAT, JTI and Philip Morris (M) (PMI), are usually made in unison.

- However unlike previous adjustments, PMI had not followed in BAT and JTI’s lead in raising its cigarette prices this time (citing a similar reason, JTI had increased its prices by the same quantum on 12 Sept 2014).

- While PMI’s decision to buck the trend may be partly due to concerns of it possibly running afoul of the Competition Act 2010 (greater scrutiny by MyCC on industry since Jan 2014), we believe a greater motivation is its desire to capture a larger share of the shrinking legal TIV pie by competing on price.

- Our view is supported by BAT’s statement which attributed its decision to its need to “remain competitive”. BAT is currently the market leader with a 62% market share while JTI and PMI hold 22% and 16%, respectively.

- The total legal industry’s volumes have been on a downtrend. As it is, 1HFY14 legal industry volumes have contracted by 7.6% YoY. The decline would have been greater were it not for the ongoing Ops Outlet carried out by the authorities to curb the proliferation of illicit cigarettes.

- Following BAT’s announcement which was closely followed by JTI’s, we have revised upwards our legitimate TIV growth assumption from -5% to -15% for FY14F-FY16F to -9% to +1%. Factoring in 1-2 ppts EBIT margin contraction, we revert to our numbers prior to the increase pending the release of its results next month. BAT’s yields are decent at ~4.5%.

Source: AmeSecurities