News

• Several online publications reported yesterday evening of the impending changes to the Tobacco minimum price laws as well as new smoking bans as agreed between the Health Ministry and the steering committee of the World Health Organization (WHO) Framework Convention on Tobacco Control (FCTC).

• Under the new changes, effective 1st August 2015, the minimum prices of cigarettes will be increased from RM7 to RM9. The floor price will increase further to RM10 by 1st August 2016.

• New non-smoking areas to be gazetted, includes all public parks, public areas in national parks and more significantly, the committee has also agreed to declare air conditioned eateries as fully smoking prohibition zones.

• According to Health Minister Datuk Seri Dr S. Subramanium, the implementation of the new non-smoking areas will be under ‘educational enforcement’ and will only be fully enforced beginning of next year.

Pros / Cons

In the near term we are neutral on the news with respect to the minimum floor price and its effects on BAT (HOLD; TP RM65.54) as the lowest price BAT sells its cigarettes for is RM12.30 (Peter Stuyvesant/ Pall Mall). The floor price to be effective 1st August is still a massive 36% wayward of the lowest selling price cigarette brand manufactured by BAT (RM9 vs. RM 12.30). We cannot foresee any up-trading from those that smoke RM7 cigarettes (legally imported Gudang Garam etc) to purchasing VFM brands due to the price hike. As such we deem this negligible to the earnings of BAT and the other two big industry players JTI and PMI.

• In the medium and long term, we are negative on the total industry volume. Previously ‘air-conditioned eateries’ were already considered a smoking prohibition zone, however the exception to the rule allowed a third of the premise to be unaffected by the ban, this privilege has been fully revoked. We believe that this will significantly alter smoker’s habits by penalizing them for the ritualistic post meal cigarette. Furthermore, this would affect the volumes sold from these trade channels and should the trend in regulations continue, there is a strong probability the non-smoking areas could also be expanded in future to include places such as pubs and all eateries, thus decimating the industry volume as a whole. Enforcement would be key, in seeing the implications to industry volume in the medium to long term.

Risks

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

Forecasts

• Unchanged.

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

Valuation

BAT: HOLD, TP: RM 65.54.

Source: Hong Leong Investment Bank Research - 31 Jul 2015