News

Several Chinese media have reported that cigarette prices will be raised by 30 sen/20-sticks pack, effective today.

On the other hand, BAT announced an increase in prices of 30 sen/pack of all its brands due to rising costs.

The Sun also reported that cigarette contents would be lessened to 15mg tar and 1.25mg nicotine by 1 Jan ’14 and 10mg and 1.0mg nicotine by June ’15.

Comments

We were surprised by the price hike as the government have just increased cigarette prices by 20 sen/pack in Oct ’12.

Following the increase, VFM-brands would have a larger price hike impact of 3.2% (RM8.70 to RM9.00), compared to 2.9% for premium brands (RM10.20 to RM10.50). Besides the reasons of rising costs, we believe pricings round-up could also be part of the reasons as well.

Despite no similar announcement by JTI & PMI, we opined that the two players would also follow suit.

Industry-wise, we believe the 30 sen increase per pack would only benefit cheap whites and illicit cigarettes as price gap widens, resulting further growth in cheap whites. Cheap whites market share currently stands at 23.5% (end-2012), recording an increase of 0.8% yoy.

We believe tobacco companies could be at a larger risk of declining volume than margin compression given the price increase may be more than enough to offset the higher costs.

Based on BAT’s volume pattern, its volume declines by 0.76% on average for every 1% increase in price. Thus, BAT’s volume could potentially fall by 2.4% or 0.21bn sticks. Assuming unchanged margins, earnings could fall by 5.3%, bringing TP to RM53.29.

On the other hand, JTI potential volume decline could not be gauged given the lack of annual cigarette volumes. However, we believe the impact would be lesser due to psychological pricing as VFM brands are still priced below RM10.

With regards to the reduction in cigarette content, we believe the impact to volume would be marginal as loss in volume from smokers who decides to quit could be offset by the smokers who stayed on as they may smoke more to obtain the same “kick” they current get from each stick.

Risks

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

Rating

NEUTRAL

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 ED hike; (3) High level of illicit cigarettes in the market; and (4) Prices already reflect fundamentals

Valuation

We are not changing our forecasts for now, pending clarification of the “higher costs”. Maintain our NEUTRAL stance on the sector, and HOLD on JTI (TP: RM6.95) and BAT (TP: RM56.19).

Source: Hong Leong Investment Bank Research - 03 Jun 2013