BREWERIES 
Solid  amid  easing  regulatory  concerns. Volumes have grown at a healthy 6.3% CAGR since the Government held back on beer excise tax hikes in 2007. We believe regulatory risks will stay relatively benign in 2013 for the following reasons: i) Malaysia's beer duties are  already  the second  highest  globally  and  the  steepest  by  far  on  a  GDP  per  capita-adjusted  basis,  ii)  liquor consumption  in  Malaysia  is  low  at  23  litres  per  capita  (excluding  the  Muslim  population),  the second  lowest  in  the  ASEAN  region,  and  iii)  a  revamp  of  the  current  alcohol  tax  structure  will likely to lead to higher incremental Government tax proceeds as opposed to a beer excise hike.

A  tax  revamp?  Brewers  are  lobbying  the  Government  to  revamp  the  current  alcohol  tax structure to better reflect the alcohol content of  their beverage. The goal is to have taxes based on alcoholic content rather than volume. Malaysia currently taxes beer of ~5% alcohol by volume (ABV) at RM7.40 per litre. Meanwhile, whiskey, at ~40% ABV, is taxed RM9 per litre, or just 22% more  than  beer  even  though  its  alcoholic  content  is  higher  by  700%.  Singapore,  Thailand, Indonesia, and even the UK are already taxing based on alcohol content instead of volume. The beer  producers  have  no  intention  of  proposing  lower  beer  taxes  but  actually  are  seeking  tax increases  on  other  alcoholic  beverages.  This  will  give  the  Government  other  avenues  to  raise alcohol tax revenue, instead of targeting beer, due to its higher volume.

OVERWEIGHT  on  Breweries. With no duty hike foreseen  for the medium term,  we expect the beer manufacturers to register a 4% volume growth in 2013. The sector is enjoying revenue and profit  expansion  both  from  growing  sales  volumes  and  improved  ASPs  as  a  result  of  a  more favourable product mix  - drinkers are consuming more higher-priced beers, thus boosting profit margins. We continue to like the sector's defensiveness as  beer  consumption  tends  to  be extremely insensitive to GDP growth.

TOBACCO
Regulatory risks to intensify  in 2013. The Government predictably kept tobacco excise duties unchanged for the second consecutive year in the 2013 Budget announcement in a bid to reduce the  prevalent  illicit  trade  as  well  as  provide  a  people-friendly  budget  in  view  of  the  impending general election. Government authorities nonetheless forced a  cigarette price hike a month later when it mandated (calculated as 20% of ex-factory price). We see rising regulatory risk in 2013, especially after the polls, both in terms of pricing as well as non price-related regulatory tightening.

Tepid volume growth. Legal cigarette consumption rose a meagre 1.7% in 9MFY12 despite the first  unchanged  tobacco  duty  in  nine  years  and the Government's cash handouts to the rural poor. We expect legal cigarette volume growth to dip back into negative territory in 2013-2014 in the  presence  of  a  tobacco  excise  duty  hike  and  the  absence  of  feel-good  Government  cash handouts  next  year.  Legal  volumes  contracted  at  an  annual  rate  of  4.1%  in  2006-2011.  Illicit trade  remains  worryingly  high,  with  the  duty  on  3.5  packs  out  of  every  10  packs  of  cigarette smoked in Malaysia not paid for.

UNDERWEIGHT  on  Tobacco.  We  believe  regulatory  risk  will  intensify  after  the  impending general election, with a likelihood of tobacco duty being raised again in the 2014 Budget. Further regulatory  tightening  is  in  the  pipeline,  including  tar  and  nicotine  content  reduction,  increased smoke-free areas and larger graphic warning signs. Given the prevalence of substitute products (illicit cigarettes), legal cigarette demand may not be as inelastic to price as it may seem.

Source: OSK