Highlights

• The Confederation Of Tobacco Manufacturers (CMTM), which consists of the 3 main tobacco players in the country, namely BAT, PMI and JTI, in a statement has urged the government to consider an excise freeze and address the issue of illicit cigarettes, which has escalated to an estimated 45.6% of the total tobacco market as at December 2015.

• The CMTM asserts that due to the magnitude of the excise duty hike of 40% in November 2015, coupled with the low consumer sentiment, the domestic tobacco industry is facing a crisis. Industry volumes have plunged by circa 30% since the excise hike.

• CMTM asserted that the government stands to lose circa RM4bn in excise duty and anticipates that soon the illicit market will overtake the legal market due to the signi ficant price gulf (RM15-17 vs. RM3-5).

Comment

• The quantum of recent increases in excise duty and the subsequent increase in cigarette prices are magnanimous and it’s not surprising that the sector is feeling the pinch. To recap post excise duty hike, premium brands were raised by 23.2% (RM13.80 to RM17.00) whilst VFM were raised by 26.1% (RM12.30 to RM15.50).

• Volume. We reiterate our belief that the steep excise hike would decimate the legal industry volume. Whilst we have imputed a double-digit decline in 2016 TIV, the reported drop in volume by CMTM has exceeded our forecast. We opine that this could be a kneejerk reaction following the excise duty hike in November. We continue to expect full year TIV decline but at a lesser rate.

• Illicit. It is apparent that the market share of illicit cigarettes has benefited from the wider price gulf between illicit and duty paid cigarettes. The CMTM figures indicate that the illicit market has gained 10.9ppts to a record high of 45.6% from 34.7% (Wave 2, 2015).

• Vaping. In our recent tobacco industry report, we highlighted that the vaping phenomenon which has induced smokers to switch between smoking and vaping. Whilst there is no data to substantiate the migration of smokers to vaping, our market survey indicates that the uptake rate is relatively high considering the vaping industry did not exist prior to 2013.

• Measures. Recall that BAT announced that it would be closing its manufacturing plant, effectively changing its cost structure in view of the challenging operating envi ronment. Another player, i.e. Phillip Morris has introduced a line of cheaper cigarettes (Chesterfield) priced at RM12, which is below the VFM category price point of RM15 industry wide.

Risks

• (1) Exceptionally higher excise duty hike; (2) Increase in illicit trade volume; (3) Weaker-than-expected TIV; (4) Regulation tightening and (5) The unregulated Vape industry.

Rating

• We maintain our Neutral call but note the heightened regulatory risk, significant volume pressure and longer-term risk from rapid growth of vape users. Despite the efforts by customs in curtailing the importation and distribution of illicit cigarettes, the wider price gul f has made it extremely lucrative for non-regulated players to enter the industry.

Source: Hong Leong Investment Bank Research - 28 Mar 2016