- We reiterate our HOLD recommendation on British American Tobacco (M) (BAT) with a slightly lower DCF-derived fair value of RM70.10/share, which implies an FY15F PE of 21x.

- We understand that BAT has reduced the prices of all its cigarette brands by 20 sen/pack (-1.4% to -1.6%). The retail selling price (RSP) for each 20s pack is now RM13.80 for the premiums, i.e. Dunhill, and RM12.30 for the aspirational premium labels, namely Pall Mall and Peter Stuyvesant.

- This reduction came as a surprise given that BAT had only recently (on 1 April 2015) increased prices of all its brands by 50 sen/pack (+3.7% to +4.1%). The rationale it had cited for the increase was the government’s implementation of the Goods and Services Tax (GST) of 6%.

- While the oligopolistic nature of the industry means that price adjustments are usually made in unison (with BAT the price leader given its dominant position with a 61% market share), recent trends have shown that this is no longer the case.

- As it is, during this latest round of price adjustment, Philip Morris International (PMI) had increased its cigarette prices by a lower 40 sen/pack while JT International (JTI) had opted to maintain prices.

- We believe that the pricing decisions by its peers may have led BAT to lower the quantum of its hike. The cigarette manufacturers now appear to be competing on price to capture a larger share of the shrinking legal TIV pie (FY14: -4.4%). The last known price war was in 2007, which is before the introduction of a minimum RSP (2010) and prohibition of price discounting (2012).

- We note that this is also the second time that BAT has qualified its price hike announcement. Recall that in September 2014, it had reversed its RM1.00/pack hike as PMI did not follow suit. Its earlier decision had resulted in its volumes declining 1.9% QoQ.

- While we do not believe that its volumes will be as negatively impacted given the smaller differential this time, we suppose that BAT could have lost some market share to PMI given their premium-skewed mix, and to JTI due to downtrading activities and the latter’s status quo prices.

- All in, we have tweaked our FY15F-FY16F earnings estimates lower by 1%-2% after incorporating the new RSP and YoY legal TIV declines of -7% and -4.5% (vs. -8% and -5%, previously). Bearing in mind the government’s Price Control and Anti-Profiteering Act 2011, BAT could now be absorbing a larger portion of the GST. This could be detrimental to its margins. We have thus assumed an EBITDA margin contraction of ~0.5ppt.

- Valuation-wise, BAT is currently trading at an FY15F PE of 21x with yields of 4.8%.

Source: AmeSecurities Research - 14 Apr 2015