Highlights

There were no major updates/ news announced during the analyst briefing which was held yesterday, 22 May 2013.

Industry data showed that JTI outperformed the industry this time around, recording a decline of 3.8% in volume yoy vs. total legal industry’s decline of 4.7%.

Looking at sales volume yoy, TIV continued to soften further. We believe this could be due to the increase in cigarette prices by 20 sen/pack back in Oct 2012.

Management also signaled that despite the marginal price increase after having zero-excise duty hike for 2 consecutive years, psychological pricing still play a role to the decline in volume given that premium pack is now sold above the RM10 threshold.

This continued to raise concerns on the level of illicit cigarettes as illicit whites continued to be on the uptrend channel (see figure 4).

As for its widened margins, this is mainly coming from the higher selling prices which more than offset the increase in ex-factory pricing of cigarettes, as well as the better product mix between premium and VFM (premium cigarettes has higher margins).

Inventory in 1QFY13 recorded a drop as JTI has completely stopped purchasing tobacco leaves locally. It is gradually using up its local leaves before switching fully to imported leaves. JTI’s local leaves inventory could last the group for 12-18 months, hence we expect margins to ramp up significantly by 2HFY14 onwards. Malaysia’s tobacco leaves is said to be the second most expensive in the industry.

The group is taking baby steps in the rebranding exercise of Mild Seven to Mevius by only changing its name for now. JTI intends to carry out a smooth migration to Mevius without creating confusions among consumers on the product.

For FY13, management highlighted that the group will be incurring higher capex (~RM60m), with plans to have more production line as well as machines to improve their products’ packaging.

Risks

• Exceptionally higher ED hike.
• Increase in illicit trade volume.
• Weaker-than-expected TIV.
• Regulation tightening.

Forecasts

Unchanged.

Rating

HOLD

• Positives – (1) High dividend yield stocks; (2) Countercyclical share price pattern; (3) Oligopoly industry; and (4) Resilient earnings and low capex requirements.
• Negatives – (1) Highly regulated industry; (2) Potential excise duty hike; (3) High level of illicit cigarettes in the market; and (4) Prices already reflect fundamentals.

Valuation

• Maintain HOLD and target price of RM6.95 based on DCF valuation.

Source: Hong Leong Investment Bank Research - 23 May 2013