Staying Upbeat on Its Revival

British American Tobacco (BAT) initially raised cigarette prices postSST by RM0.50 per pack before subsequently rolling the hike back, pending regulatory approval. The minor hike, if maintained, would not have caused a big drop in volume sales, in our view. We nevertheless anticipate further duty hikes and consequently higher prices over the coming years, which in our view will induce moderate downtrading. Still, BAT’s outlook remains bright, hinged upon the Pakatan government’s adherence to quash the illicit cigarette market’s dominance, which we expect to materialise from 2019 onwards under Pakatan’s political will and fiscal motivation. Reiterate our BUY recommendation with a revised CY19E DDM-derived TP of RM39.10.

Small Hikes, Price Competition Re-emerges

The initial price hike of RM0.50/pack across BAT’s premium, aspirational premium and value-for-money (VFM) brands would have propped up its supply chain’s margins, while the impact to volume sales would have been marginal, in our view. However, a pricing differential has re-emerged, with Phillip Morris’ brands such as Marlboro having raised prices by RM0.20/pack. JTI‘s brands were raised by RM0.50/pack barring its VFM brand, LD which was raised by RM0.30/pack. Price gaps between the Big- 3 players have nevertheless quickly converged in the past.

Illicit Trade Inching Closer Onto Government’s Priorities

We hold onto our view that the black market has already plateaued and would not be exacerbated further by a price hike. We also continue to believe that the legal tobacco industry is poised for an earnings recovery under the Pakatan-led administration. With the looming Budget 2019, the illicit trade and its multi-billion tax leakages will likely undergo greater scrutiny by the administration in the coming days.

Maintain BUY

We revise FY18-20E EPS lower by -2.1%/-9.3%/-10.7% after pricing in SST absorption alongside a gradual shift in portfolio mix favouring cheaper brands, erring on the side of caution with further affordability-driven initiatives by the government to control smoking rates. Despite that, the stock remains largely below its fair value, while offering attractive yields of 4.5%-6.3%. Near-term curtailment of the illicit trade could be a re-rating catalyst. Reiterate our BUY call on BAT, with a revised 12-month DDMderived TP of RM39.10. Downside risks: i) weaker-than-expected enforcement initiatives; and ii) aggressive excise duty shocks.

Source: Affin Hwang Research - 26 Sept 2018