News

BAT through its subsidiary, Commercial Marketers and Distributors Sdn Bhd has announced that the prices of cigarettes under its brands will be increased by 16.0 sen/stick or RM3.20/packet effective 4 November 2015.

The new prices of Dunhill, Benson & Hedges, and Kent will be raised to RM17.00 (from RM13.80) while Peter Stuyvesant and Pall Mall prices will be increased to RM15.50 from RM12.30.

The new prices indicate increases of 23.2%-26.0%.

Comments

We were surprised by the price increase which is driven by the excise duty hike as we initially thought that any excise duty hike would be announced in the Budget 2016 and the chances are slim considering the GST implementation earlier this year. We understand that the excise duty has been raised by 12.0 sen/stick from 28.0 sen/stick to 40.0 sen/stick (or RM8.00 /packet). The quantum of the excise duty hike of 42.9% also took us by surprise.

We view the price increase NEGATIVELY to the whole legal tobacco industry which has recorded a 10.9% decline in industry volume as of 9M15 on the back of weak consumer sentiment attributable to GST implementation.

From BAT perspective, we think that the competitors will follow suit as the steep hike in excise duty is unlikely to be absorbed. Thus, with the price increase, we expect the illicit trade to return to strength as consumers down trade to cheaper illicit cigarettes. To recap, the successful enforcement has reduced the illicit market share from high of 38.9% in end-2013 to 32.3% in end-2014.

Outlook

We are bearish on the latest round of price increase in response to the excise duty hike, which we think may significantly hurt the legal tobacco industry by accelerating the pace of the industry volume decline.

Although the price increase is more than sufficient to negate the excise duty hike, we think the impact to bottom line is negative considering the potential decline in sales volume. Thus, we turned negative on BAT as well as the legal tobacco industry as a whole as the illicit trades might grow by capitalising on the situation and thus, posing a greater threat to the legal industry.

Forecast

We factor in the new prices and excise duty structure but assume higher industry volume decline of 12% and 5% in FY15E and FY16E, respectively (from -7% and +1%). As a result, FY15E and FY16E net profits were trimmed by 3.8% and 5.3%, respectively.

Rating

Downgrade to UNDERPERFORM from MARKET PERFORM

Valuation

Correspondingly, with the earnings cut, our Target Price is also revised down to RM60.00 (from RM65.45). Our TP is based on lower FY16E PER of 18x which implied -1 SD over 5-year mean from 18.6x (-0.5SD) previously. We think that a more conservative valuation is justifiable to reflect our pessimism over the legal tobacco industry in Malaysia.

Risks

Lower-than-expected market share.

Excise duty hike.

Source: Kenanga Research - 4 Nov 2015