British American Tobacco (ROTH) has raised its cigarette selling prices by MYR0.30 per pack,  citing higher operating cost and  the proliferation of  illicit  cigarettes  for  the  price  increase.  While  the  price  hike  appears small  at  first  glance,  it  is  sufficient  to  cover  the  77.5%  increase  in operating cost. Maintain NEUTRAL, with FV of MYR61.07.

- Every  puff  gets  dearer.  News  reports  said  ROTH  will  increase  its premium  cigarette  selling  prices  by  30  sen  per  pack  to  RM10.50  and  to RM9.00 for value-for-money (VFM) brands, effective today. We checked this out at a local 7-Eleven store this morning and found that prices have indeed  increased.  The  cashier  indicated  that  the  prices  of  rival  brands from JTI and PMI will also be raised soon.

- Rationale  for  price  hike.  Management  cited  rising  operating  costs driven  by  inflationary  pressure,  as  well  as  higher  labour  and  input  costs the key  factors  for  the  2.9% price increase.  The  company  also  said  that the  existing  high  level  of  illicit  trade  in  Malaysia  –  at  34.5%  of  all cigarettes  -  has  negatively  affected  the  sales  of  legal  cigarettes.  This,  it said, made the price increases necessary to protect profits.

- A  80%-100%  increase  in  cost?  We  estimate  that  the  non-tobacco  tax related cost of sales only accounts for 4.5%-5.7% of ROTH’s total cost of sales,  with  the  rest  consisting  of  excise,  sales  and  ad  valorem  taxes. Based on a 2012 gross profit margin of 34.3%, a 2.9% increase in selling prices  will  be  sufficient  to  cover  a  77.5%-98.2%  increase  in  cost  of  raw materials  and  packaging  as  well  as  production  labour-related  cost, assuming that duties are unchanged.   

- Tackling  illicits.  ROTH  also  opted  to  increase  selling  prices  due  to  the persistently high incidence of illicit cigarettes. We think this runs contrary to what it has been telling the authorities  – that an increase in taxes will lead to higher selling prices and in turn causes illicit trade to spike up.

- Maintain  NEUTRAL. We are keeping our  forecasts  unchanged  pending clearer  indication  from  Management  on  the  magnitude  of  the  cost increase and if tobacco taxes have been raised. Our FV is unchanged at MYR61.07, based on FCFF (WACC: 5.5%, terminal growth: 1.0%)

Source: RHB