News

BAT announced that it will be raising its cigarette prices by RM1.50/20-stick pack for both its premium and VFM-brands respectively effective today, 30 Sept 2013.

However, there were no reasons disclosed behind the price increase.

Comments

The price hike announcement turned out to be a negative surprise and the move is the third increase over the last two years (or second time in 2013).

To recap, BAT increase its cigarette prices by 20 sen/pack in Oct 2012 due to the hike in ex-factory pricing and another 30 sen/pack in June 2013 due to rising costs.

Following the increase, VFM-brands would have a larger price hike impact of 16.7% (RM9.00 to RM10.50), compared to 14.3% for premium brands (RM10.50 to RM12.00).

We believe the price increase would result in a larger impact towards BAT’s cigarette volume as he hike is much steeper as compared to previous hikes (2.0-2.4% in Oct ’12 and 2.9-3.4% in June).

Given that BAT is the market leader in the tobacco industry, with its total volume constituting approximately 62.9% of total legal market volume, any decline in BAT’s volume would affect industry’s volume significantly.

Despite absence of similar announcements by JTI & PMI, we opined that the two players would also follow suit.

Industry-wise, we believe the price increase would benefit cheap whites and illicit cigarettes as price gap widens significantly, which is expected to further fuel growth in cheap whites. Cheap whites market share currently stands at 23.0% (Wave 1, Mar – May ‘13), recording an increase of 0.5% yoy.

Based on BAT’s historical volume pattern, its volume declines with every price increase, recording an average of 0.97% decrease in volume for every 1% increase in price.

Although industry’s historical patterns showed that BAT’s volume underperforms the industry on average, we opined that BAT would outperform the industry post the latest price hike as a premium player vis-à-vis VFM player due to the latter’s larger percentage increase as well as pricing of above RM10 for both premium and VFM brands.

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 further information on the reason for the price increase. Maintain our NEUTRAL stance on the sector, and HOLD on JTI (TP: RM6.97) and BAT (TP: RM59.86).

Source:Hong Leong Investment Bank Research - 30 Sep 2013