News 

BAT  announced  that  prices  of  all  cigarette  brands  will  be revised  back to their l ast pricing before  8 Sept 2014.

Management  mentioned  that  the  revision  in  cigarette  prices across  the  board  was  to  allow  BAT  to  remain  competitive  in the industry, and will continue to produce high quality products for discerning consumers despite the chal lenges the group is going through.

Comments 

This  came  as  another  surpris e  as  we  believe  this  is  the  first time  in  history that  cigarette  prices  were  revised  downwards. Furthermore,  BAT  raised  its  prices  just  two  weeks  ago  on  8 Sept 2014.

To recap, BAT increased its cigarette prices by  RM1/pack due to higher operating and production costs, similar reas on to the price hike back in June 2013 by 30 sen/pack.   Hence effective 22  Sept  2014,  premium  and  VFM  brands  are  now  back  to RM12.00  and RM10.50/pack, respectively.

Despite  management’s  view  to  allow  BAT  to  remain competitive  in  the  industry,  we  opined  that  volume  may  be  a factor  as  well  as  it  could  have  been  impacted  by  the  rec ent price  hike,  of  which  we  consider  quite  steep  (premium  and VFM brands were  raised  by 8.3% and 9.5% respectively).

To date, only BAT and  JTI  have raised its cigarette prices by RM1/pack, hence with such move by BAT, we  believe that JTI would  also  revise  its  prices  downwards.  PMI  on  the  other hand have  not raised its prices since  8 Sept 2 014.  With BAT returning to its original prices, it may also be a move to protect its position as the market leader  in the industry.

However,  there  may  be  potential  squeeze  in  margin  as tobacco  players  would  have  to  absorb  any  increase  in  costs altogether,  rather  than  passing  it  on  to  consumers  as  per practiced historically.

The latest reading on illicits’  market share stands at 35.8%, a reduction of 3.1 -ppts from its peak of 38.9% in Wave 3, 2013. Despite the decline, which we believe was due to the effect ive raids  conducted  by  the  authorities,  it  is  still  considered relatively  high.

Risks 

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

Rating - NEUTRAL

• Positives  –  (1) High dividend yield s tocks; (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 

• Forec asts  for  BAT  remained  unchanged.   Maintain  our NEUTRAL  stance  on  the  sector,  and  HOLD  on  BAT  (TP: RM68.54)

Source: Hong Leong Investment Bank Research - 23 Sep 2014