Highlights

BAT  announced  that  it  will  be  raising  its  cigarette  prices  by RM1.50/20-stick  pack  for  both  its  premium  and  value -for money (VFM) brands  effective  today, 5 Nov  2014.

It  was  mentioned  that  the  reason  behind  the  price  hike  was due  to an increase in excise duty hike by the government on 1 Nov  2014.

Comment 

The  announced  pric e  hike  was  not  a  surprise  given  that  we do not dismiss any potential off -Budget excise duty hike to be imposed.

Despite  the  quantum  of  the  increase  in  excise  duty  was  not disclose, we believe it is raised by   at most RM0.30/kg, similar to  the  increase  back  in  Sept  2013  where  tobacco  operators raised its ASP by RM1.50/pack  as well.

We  view  that  the  substantial  increase  in  cigarette  prices would  further  punish  legal  players  (BAT,  JTI  and  PMI)  and benefit cheap whites and illicit cigarettes as price gap widens significantly.

Volume-wise,  we  would  not  be  surprised  if  TIV  continues  to be  impacted  by  the  following  price  hike.  Recall  that  BAT’s volume  fell  by  7%  in  Sept  ’14  alone  when  it  announc ed  a RM1/pack  price  hike,  which  lasted  only  for  two  weeks. Hence, TIV could potentially decline at a larger  quantum.

Apart  from  the  impact  on  volume,  we  believe  the  market share  of  illicit  cigarettes’  would  be  back  on  the  rising  trend after it declined by 3.1ppts in Wave 1, 2014  to 35.8%.

Given  that  the  previous  hike  (RM1/pack)  was  due  to  higher operating and production costs, we now opined that BAT may not  enjoy  the  likelihood  of  margin  ex pansion  although  the price increase are usually more than in the increase in excise duty  hike  as  the  additional  cushion  may  be  used  to compensate the higher costs.  

Despite  no  similar  announcement  by  JTI  and  PMI,  we  view that  the  two  players  would  also  follow  suit  this  time  around given that the  price hike was partially due to a hike in excise duty.

Risks

(1) Exceptionally higher excise duty  hike; (2) Increase in illicit trade  volume;  (3)  Weaker-than- expected  TIV;  and  (4) Regulation  tightening.

Forecasts

• We tweaked our  volume  forecast  lower, ex pecting  a  doubledigit decline  in FY15 and a slight recovery in FY16. As s uch, FY15-16  EPS is reduced  by 8-16%.

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

• Post-earnings  revision,  target  price  is  reduced  to  RM63.20 based on DCF valuations.  Maintain  HOLD.

Source: Hong Leong Investment Bank Research - 5 Nov 2014