JTI's  9MFY12  earnings  of  RM98.3m  (-6.1%  y-o-y)  were  within  expectations.  The tepid trade speculation prior toBudget announcement this year led to a 8.2% drop in  sales  volume  for  the  quarter,  although  4Q  sales  should  rebound  y-o-y  amid wholesalers and retailers' lower stockpiles. Winston, the country's most popular VFM  brand,  continues  to  face  challenges  as  its  price-sensitive  consumers switched to illicit cigarettes. In view of the bleak outlook for the tobacco industry, we are downgrading JTI to NEUTRAL, with our FV lowered to RM7.02.

Within  estimates.  JTI's 3QFY12 revenue and earnings were RM319.2m (-4.7%  y-o-y, +5.1% q-o-q) and RM31.2m (-21.6% y-o-y, +5.9% q-o-q) respectively. Trade speculation eased  ahead  of  the  2013  Budget  announcement,  leading  to  a  8.2%  drop  in  sales volume.  This  dragged  down  profits,  but  the  decline  was  partially  mitigated  by  a  better product  mix  (selling  more  Premium  cigarettes).  9MFY12  turnover  and  profit  came  in  at RM944.3m  (+1.3%  y-o-y)  and  RM98.3m  (-6.1%  y-o-y)  respectively,  suppressed  by higher  marketing  expenditures  for  its  new  range  of  Winston  cigarettes,  but  partly compensated by its stronger presence in the Premium segment. The 9-month earnings represent 75.5% and 77.6% of our and consensus estimates.

Inventory  swells.  We  think  the  tepid  trade  speculation  this  year  has  caught  JTI  off guard.  Its  inventory  as  a  result  swelled  by  30.6%  q-o-q  to  RM112.1m,  which  will  likely lead  to  higher  storage  expenses.  BAT,  in  contrast,  probably  anticipated  the  softer volume take-up by  wholesalers  and  retailers, hence  explaining  its  relatively  unchanged inventory value (-1.3% q-o-q).

The eagle continues to face challenges. Winston, its flagship Value-for-Money (VFM) brand,  continued  to  see  weakness  as  its  price-sensitive  consumers  switched  to  illicit cigarettes. Its key Premium brand Mild Seven, in comparison, was the bright spot for the
company with market share growing 0.3ppt to 4.3%. 

Increasing  prices.  JTI  has  increased  its  selling  prices  by  RM0.20  per  pack  on 25  Oct following  the  Government's  mandatory ex-factory  price  rise,  leading  to  higher  ad-valorem and sales taxes. This follows BAT's price hike for the same reasons on 22 Oct.

Downgrade to NEUTRAL. We are trimming our FY12 and FY13 forecasts by 4.0% and 3.9%  respectively  on  lower  VFM  volume  expectations.  4QFY12  is  likely  to  record stronger  y-o-y  earnings  as  the  lower  trade  speculation  in  3Q  this  year  should  translate into  greater  take-up  in  4Q.  Industry  prospects  for  the  tobacco  industry,  nonetheless, remain  bleak  as  regulatory  risks  intensify.  With  our  FV  cut  to  RM7.02,  we  are downgrading JTI to NEUTRAL. An interim dividend of RM0.11 was announced.

Source: OSK