Highlights

• BAT has announced that it will be raising its cigarette prices by RM0.50/20-stick pack for its premium and value-formoney (VFM) brands effective 1 April 2015.

• Post-price hike, new cigarette prices would be RM14.00 & RM12.50 for premium and VFM segments respectively.

Comment

• This hike was not a surprise as we do not dismiss any potential price hike especially with the implementation of the GST. To note, GST at 6% was implemented yesterday.

• Under the Price Control and Anti-profiteering (amendment) Act (2014), retailers are disallowed to increase their “net profit margin” for any goods or services for 18 months from Jan 2015 to June 2016. This however does not mean that businesses can’t raise prices due to inflationary pressure on cost such as a tax on inputs where previously there was none.

• The quantum of the increase in prices is less than the 6% (GST) whereby premium brands was raised by only 3.57% while VFM brands was raised by 4.16%.

• The GST is a value added tax that is intended to replace the sales tax (5%), note that Ad Valorem tax as well as excise duty is still very much a part of their cost structure.

• In terms of volume, we believe the market share of illicit cigarettes’ (which has been in decline in the past two wave studies) could return to its increasing trend. Recall that the Wave 2, 2014 study showed a decline of 3.5ppts to 32.3%. The increase in cigarette prices would further put pressure on legal industry volume as the price gap widens further (legal volume vs. illicit volume).

• To note, we had already imputed a double digit decline in volume for FY15 to account for the significant hike of RM1.50/20- stick pack in Nov 2014 and GST implementation.

• Despite no similar announcement by JTI and PMI, we view that the two players would also follow suit as GST is implemented across the board.

Risks

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

Forecasts

• We maintained our volume forecast, expecting a double-digit decline in FY15 and a slight recovery in FY16. Our forecast remains unchanged as the price increase is offset by the increased costs due to the GST.

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

Target price remains unchanged at RM63.20 based on DCF valuations. Maintain HOLD.

Source: Hong Leong Investment Bank Research - 2 Apr 2015