BAT announced that they have increased shelf prices for all cigarette brands by RM0.40 per pack. While this will result to higher margins, the incidence of illicit trade could worsen. Forecasts remain unchanged. As we expect any margin expansion from higher prices to be mitigated by lower volumes in the near term. We maintain our HOLD call and DCF derived target price of RM 32.80 (WACC: 8.4%, TG: 3.0%).

NEWSBREAK

BAT announced that they have increased shelf prices for all cigarette brands by RM0.40/pack, effective 2 Nov 2018 following guidance from the Ministry of Health. This represents a price increase of around 2-3%.

HLIB’S VIEW

Post-SST pricing confusion over. We are not surprised by this news as BAT had guided that they intended to raise shelf prices, subject to approval from the Health Ministry. Note that BAT did increase prices by RM0.50 at the onset of the SST regime on 4 Sept 2018 before reverting to pre-SST prices on 21 Sept. While this is positive to margins, it may result to an even higher incidence of illicit trade in the short term, which currently accounts for 62% of market share). The price differential between legal and illicit versions has widened even further with this price hike (legal Dunhill: RM17.40 vs. illicit: RM4-5).

BAT currently has the most expensive brands in each category. With the recent hike in shelf prices, BAT currently has the most expensive brand in each category (premium, aspirational and VFM) amongst the Big-3 tobacco players (Figure 1). We are unperturbed by this as BAT commands approximately 55% of legal market volumes, allowing the group to be a price leader, rather than a price taker. We note that Phillip Morris International’s shelf prices have increased by RM0.20 since the onset of SST regime, while JTI has yet to raise selling prices.

Government aims to recover RM1bn in lost tax revenue. In the recent Budget 2019 announcement, the government announced its desire to clamp down on the illicit tobacco trade, aiming to collect at least RM1bn in lost tax revenue. As we estimate that RM1bn represents 13% of the total tobacco market, achieving this target could lower illicit trade to 50% of total market share from 62% currently (Figure 2).

Outlook. BAT’s profitability still remains at the mercy of the thriving illicit market. Should it materialise, the government’s planned clamp down on the illicit market should drive volumes back to legal players and greatly benefit BAT. While we are positive on this news, we understand this endeavour will take time to bear fruit. As such, we are reticent to factor in significantly lower illicit market share until we see any significant illicit market share decline.

Forecast. Unchanged. As we expect any margin expansion from higher prices to be mitigated by lower volumes in the near term.

Maintain HOLD, TP: RM32.80. We maintain our HOLD call and DCF-derived target price of RM 32.80 (WACC: 8.4%, TG: 3.0%).

Source: Hong Leong Investment Bank Research - 7 Nov 2018