Based on the strong reception of the IQOS in other countries, we expect IQOS to claim 5% of the total tobacco market by end-2019. We lower our FY19/20 forecasts by 8.3%/18.2%. We downgrade our call from a Hold to a SELL with a lower TP of RM24.50 from RM32.80 after our earnings adjustment based on a DCF valuation methodology (WACC: 8.4%, TG: 3.0%).

What is the IQOS and how does it work? The IQOS (Philip Morris International) (Figure #1) is a ‘heat-not-burn’ (HNB) device which heats up refillable ‘Heets’ to 350°C without combustion (regular cigarettes reach temperatures of over 600°C). Unlike regular cigarettes, the IQOS emits dry vapour instead of actual smoke, meaning that the level of harmful chemicals are significantly reduced compared to cigarette smoke (PMI). The IQOS heating device is priced at between RM260 and RM390 while a pack of 20 HeatSticks cost RM14. Devices can be found at authorised sellers and selected vape shops while ‘Heets’ can be purchased from 7-Eleven and MyNews convenience stores and selected Petronas petrol stations.

Popularity of the IQOS in other markets. Currently, the IQOS is available in Japan, S. Korea and a number of European nations (Figure #4-6). Since its launch in Japan approximately three years ago, IQOS has managed to amass 15.5% of the total tobacco market. Impressively, in S. Korea, IQOS has captured 7.4% of market share within 18 months of launch.

Expected IQOS market share. Based on the strong reception of the IQOS in other countries, we expect IQOS to claim 5% of the total tobacco market in FY19 given that Malaysian consumers have shown a willingness to try new tobacco products. Note that vape, which peaked at over 15% market share in 2015 and BAT’s VFM brand Rothman’s grew to ~3% of market share in 3Q18 in since its launch.

BAT and JTI alternatives ‘Glo’ and ‘Ploom’ already available in other markets.

Given that Glo (available in multiple other countries) and Ploom (available in Japan only) have comparable HNB devices, we expect BAT and JTI to follow suit in launching Glo and Ploom in Malaysia within the coming quarters.

Impact of potential launch of Glo in Malaysia. Given that BAT possess a HNB alternative to the IQOS, we expect BAT to launch Glo in Malaysia in FY19 or risk losing significant market share. Note that BAT launched Glo two quarters after PMI launched the IQOS in S. Korea. We expect BAT to incur significant start-up costs from marketing of this new product. Assuming the pricing for Glo is similar to IQOS, we expect the launch of Glo to have a favourable impact on margins given the favourable excise duty cost of 24% retail price (RM4.80 per pack of RM14.00) vs 46% (RM8.00 per pack of RM17.40) for premium cigarettes.

Smoking banned at all eateries nationwide from 1 January onwards. MoH announced that going forward, smokers will be required to be at least 3 meters away from the premise before lighting up. The punishment is expected to be set at RM10,000 fine or up to 2 years in jail. However, MoH guided that the first 6 months will serve as a grace period. We expect the smoking ban at eateries to have an impact on cigarette sales as many eateries have reported a decline in number of customers purchasing cigarettes. Additionally, we note that a popular “mamak” chain “Pelita” has announced that they will be ceasing cigarette sales completely.

Source: Hong Leong Investment Bank Research - 22 Jan 2019