Checks confirmed a 40.0 sen price increase per pack across all cigarette brands. We keep our pessimistic outlook of the tobacco industry due to the overwhelming presence of illicit products, amidst government efforts to curb the illegals to regain excise duty income. The implementation of “smoke- free” zones could also pose a challenge to industry volume. Maintain UP but with a higher TP of RM29.10 (from RM28.25).

40.0 sen across the board. To recap, BAT and certain tobacco players had retracted their SST-led price of 50.0 sen/pack in late-September. This was pending guidance from the Ministry of Health (MoH) on the appropriate price increase. Post-Budget 2019, the quantum has been determined at a minimum increase of 40.0 sen per pack. With this, premium brands are priced at RM17.40, aspirational premium brands at RM15.90 and value-for-money at RM12.40. The adjustment appears to be uniform across BAT’s peers.

Balancing the scale. During the lapse prior to MoH’s official guidance, BAT commented that it would absorb the relevant tax gaps from charging cigarettes at the old prices. Our volume assumptions indicate an expected pullback of less than RM30.0m from this. Still, the margin gains during the “tax-holiday” between June-August 2018 could provide some leeway in managing this cost.

During the Budget 2019 announcement, it was presented that the government intends to regain RM1.0b in lost excise duty income caused by the rampant illicit trade market, which accounts for 63% of total industry volume. This could be led by the Royal Malaysian Customs’ newly launched SST system which could enhance enforcement methods. However, concurrently, the government aims to establish smoke-free zones by January 2019, which would lead to fines for smoking at various premises (i.e. outdoor food outlets). We suspect the successful implementation of the two may lead to a zero-sum scenario to the tobacco industry, whereby the overall market may see a higher legal purchase mix but at a lower market share. At the meantime, we maintain our cautious view of the overall tobacco industry as the alarming levels of illegal products persists, undermining the effectiveness of various efforts taken by regulatory bodies.

With this update, we adjust our FY18E/FY19E effective prices, which could lead to some minor improvements in the product mix. Premium brands will continue to be the leading contributor of the group at 77%/75% of total sales volume in FY18/FY19. Overall, this led to a 1.3%/3.0% adjustment to our earnings assumptions.

Maintain UNDERPERFORM but with a higher Target Price of RM29.10 (from RM28.25, previously). This is based on an unchanged 18.0x FY19E PER (-1.5SD 3-year mean) on a revised EPS. Dividend yield of 4.0% for both FY18E/FY19E may seem decent, but is likely to be dampened by potential capital downside.

Risks to our call include: (i) faster-than-expected recovery of legal market share, (ii) lesser-than-expected conversion towards less premium brands, and (iii) significant decrease in forex to improve cost of sales.

Source: Kenanga Research - 09 Nov 2018