News  Media reported that the price of a pack of 20s will go up, effective Sept 8, by RM1 to RM13 for British American Tobacco (BAT) Malaysia brands, namely Dunhill, Benson & Hedges and Kent.

 The prices of Lucky Strike and Rothmans brands are expected to increase to RM13.50 per pack while Peter Stuyvesant and Pall Mall will increase RM1 as well to RM11.50 for a pack.

 The new prices across the various brands represent an increase of 8%-9.5%.

Comments  We were not surprised by the timing as the last hike of cigarettes price (Sept 2013) also happened during this time period, on the back of higher excise duty on tobacco of 14%. However, we were slightly surprised on the price increase as the industry is already facing heightening challenges from the illicit cigarettes which commanded significant market share of 38.9% during the Oct-Dec 2013 period.

 Thus, we expect downtrading or brand substitution to the illicit cigarettes where retail prices are significantly lower by more than 50%. The illicit trades are expected to be toned down following the effort of the Royal Malaysia Customs

(RMC) through Ops Outlets operations from March 2014 till present, but we reckon that the continuous efforts would be sustained or further strengthened following this round of price hike.

 All in, we are NEGATIVE on this development as we reckon that the price increase is detrimental to the tobacco industry as the market share of illicits was high, nearing the 40% mark (38.9% during Oct-Dec 2013).

 Ceteris paribus, we expect the latest price hike to boost BAT’s FY14-FY15 net profits by 9.2%-27.8% (assuming no excise duty hike), 7%-21% (assuming excise duty increases by 1 sen/stick), 4.8%-14.1% (assuming excise duty increases by 2 sen/stick) and 2.6%-7.3% (assuming excise duty increases by 3 sen/stick).

Outlook  We maintain our negative stance on the outlook of the company as well as the overall industry. Despite the declining industry volume, earnings numbers appear to be encouraging mainly supported by the higher selling price after the last revision in Sept 2013, but the consumption volume has been shrinking. Outlook could be further dented with the imminent implementation of GST in April 2014.

Forecast  We leave our earnings estimates unchanged at this juncture pending further and clearer indication from the management on the quantum or magnitude of the increase in excise duty, if any, and the increase in costs.

Rating UNDER REVIEW

Valuation  We are reviewing our CALL/TP pending further clarification from the company in regards with the basis of price increase. Our previous call was UNDERPERFORM with a TP of RM64.50 based on 20x 2015F EPS of 322.9 sen.

Risks to Our Call Better-than-expected of RMC’s success in clamping down illicit trade, which would benefit the legal market’s TIV and BAT.

Source: Kenanga