The Royal Customs Department of Malaysia has declared a 10% sales tax to be charged against alcoholic beverages and tobacco products. This is a negative to the Sin sub-sector as valueadded taxes are typically passed on to consumers, leading to an industry-wide increase in prices. End consumers of alcoholic beverages may also bear the brunt of an additional 6% service tax to the final price from on-trade purchases. Although this sector is deemed to enjoy inelastic demand, the previous GST-led bump in prices resulted in slower domestic sales performance from the brewers while tobacco players are still plagued by rampant illicit cigarette trade. In lieu of the above, we reduce our FY18E/FY19E earnings assumptions for BAT, which resulted in an UNDERPERFORM rating (from MARKET PERFORM) with a lower TP of RM27.10 (from RM34.10). CARLSBG is also adjusted to reflect a softer outlook, re-rated to UNDERPERFORM (from MARKET PERFORM) with a lower TP of RM17.10 (from RM18.25). While we reserve making changes to HEIM pending its results release tomorrow, we take this opportunity to re-rate the stock to MARKET PERFORM (from OUTPERFORM) as its share price has moved closer to our unchanged TP of RM23.30. Overall, we UNDERWEIGHT (from NEUTRAL) the Sin sub-sector following this industry-negative development.

Hurtful new tax environment for sin goods. Following the passing by the Dewan Negara on 20 August 2018, The Royal Customs Department of Malaysia declared that on 1 September 2018, a 10% sales tax will be implemented on sin goods in addition to a 6% service tax on food service establishments with an annual turnover of RM1.0m and above. This differs from the Pre-2015 sales and service tax (SST) regime whereby alcoholic beverages and tobacco products were charged a 5% sales tax while food establishments with an annual turnover of RM3.0m and above will be liable to pay service taxes.

More salt on tobacco players’ wounds. Based on restrictions imposed by the Ministry of Health, tobacco players are not permitted to absorb value-added taxes and excise duties or reduce prices from the ceasing of such. Hence cigarette prices remained constant despite the zerorating of GST since June 2018. With the reintroduction of sales taxes, the new 10% rate would be charged on the current “taxfree” retail prices to inflate prices further. This would be highly unbeneficial to the legal cigarette market as illicit cigarette sales have become alarmingly rampant due to its availability and affordability. Recall that is it estimated that illegal sales account for 63% of the industry volume as of June 2018. Therefore, it is highly anticipated that further price pressures would aggravate the leakages from the legal market share. Down-trading is also likely to occur where consumers may opt for more valueofferings,y offerings which are of lower margins compared to premium brands.

Double whammy for brewers. We gathered from CARLSBG that brewers are more fluid with price adjustments to value-added taxes, reducing prices in reflection of the zero-rating of GST. Although raising prices with the new sales tax would appear to be in the ordinary course of business, the new 10% tax rate is an increment from the previous sales tax regimFurthermore,ich charged 5%. Also note that brewers sell products through two different channels, being on-trade (i.e. owners of food establishments) and off-trade platforms (i.e. supermarkets, convenience stores). From the new criteria stated above,establishments, on-trade establishments which see an annual turnover of RM1.0m and above are now liable to pass an additional 6% service tax for alcoholic products sold there. While this does not directly impact the brewers as they do not sell to the end consumers in this channel, the higher on-trade selling prices further may undermine consumer demand there. Though we have yet to obtain input from HEIM’s management, pending the upcoming results briefing, we believe these aspects should be highly similar due to their identical businesses.

Downgrade the Sin sub-sector to UNDERWEIGHT. Generally speaking, come the SST implementation in September 2018, sin stocks are expected to push for higher average selling prices as they pass down the additional taxes, dampening demand and eroding profits in the coming financial years. With these adjustments made to our FY18E/FY19E assumptions, we downgrade BAT to UNDERPERFORM rating (from MARKET PERFORM) with a lower TP of RM27.10 (from RM34.10) from an unchanged 18.0x FY19E PER. CARLSBG is also rerated to UNDERPERFORM (from MARKET PERFORM) with a lower TP of RM17.10 (from RM18.25) on an unchanged 19.0x FY19E PER. While we reserve making changes to HEIM pending its results release tomorrow, we take this opportunity to rerate the stock to MARKET PERFORM (from OUTPERFORM) as its share price has moved closer to our unchanged TP of RM23.30 on its 20.0x FY19E PER. However, we anticipate a c.4-10% trimming to HEIM’s earnings and TP assuming its results are as expected. With the abovementioned poor outlook coupled with the new UNDERPERFORM ratings of our stock coverage, we downgrade the Sin sub-sector to UNDERWEIGHT (from NEUTRAL).

Recollecting the reason for reintroducing SST. The move to reintroduce SST stemmed from the present government’s effort to curb general inflation across all consumer goods. While the previous GST structure charged up to c.11,200 different goods, the scope of the SST covers 6,400 total goods. However, we believe that it is because of the loss of tax revenue driven by this that sales tax rates for goods under certain categories (i.e. sin goods) were imposed a higher rate to make up for that short fall. In addition, more stringent criteria to get a broader range of service providers to pay service tax could also be led by this motive.

Source: Kenanga Research - 27 Aug 2018