News

• The Star reported that Deputy Health Minister Datuk Seri Dr. Hilmi Yahya was quoted saying that the government will increase the prices of cigarettes from RM17 currently to RM21.50 as part of a sleuth of measures aimed at reducing smoking in Malaysia.

Comment

• Historically, a price hike is an evolution of an excise revision. Another excise led price hike in the near term could prove fatal for BAT. Whilst the exact time frame was not mentioned, this can be construed as a signal that the government has intentions to revisit excise duties (ED) after a one year hiatus.
• A hike of RM4.50 (RM17 to RM21.5) would represent an increase of 26.5% for premium cigarettes. Based on this we extrapolate that VFM brands would also be raised by the same quantum, which would represent a 29% increase (RM15.5 to RM20).
• We are coy on the timing as the industry is still facing the pains from the previous excise led price hike of 40% in Nov 2015. Softness in consumer sentiments persists whilst affordability remains a pertinent issue. This would also take prices above the RM20 psychological barrier for consumers.
• Recall that BAT’s and industry volumes contracted 29.7% and 25.7% yoy in FY16 as a result of the Nov 2015 excise revision, whilst illicit market share grew to a record of 51.2% in FY16 (FY15: 36.9%).
• Based on the Nov 2015 experience, a simple linear extrapolation implies that a RM4.50 price increase (+26%) would suggest TIV decline by 34% ceteris paribus.
• Assuming (i) 34% decline in TIV and (ii) the entire RM4.50 (+26%) price hike is due to ED, we estimate BAT’s FY17-19 earnings to decline by 39-43%. However, we note that the magnitude of earnings decline would be mitigated should BAT increase prices by a quantum greater than the ED hike.
• Other tobacco control measures in consideration include plain packaging, which has proven a relative success in Australia. Introduced in 2012, plain packaging laws required health warnings to cover 75% of the front and 90% of the back of cigarette packaging. Currently, cigarette packaging in Malaysia are only required to cover 50% of the front and 60% of the back.
• BAT will continue to suffer from price based substitution as consumer affordability remains the key issue whilst the pie of smokers within the legal industry would continue to shrink.

Risks

• As elaborated, such a drastic price hike would result to TIV decline coupled with a growing illicit market.

Forecasts

• Unchanged pending more details from an official announcement on potential said price hike.

Rating

#bull# While the risk of TIV decline has certainly heightened, there

• are green shoots from BAT’s move to an asset light model via the outsourcing of its manufacturing. Maintain HOLD.

Valuation

• Our DCF derived TP remains at RM48.23 (WACC: 8.2%; TG 3.0%).

Source: Hong Leong Investment Bank Research - 30 Mar 2017