We downgrade RJR to SELL, with a lower MYR5.72 FV (from MYR6.93) given: i) its rich valuations, ii) slowing industry volume growth, and iii) a possible tobacco excise duty hike. Given rising bond yields, we believe that  companies  that  dish  out  high  dividends  despite  limited  growth opportunities  do  not  deserve  such  high  P/E  valuations.  Note  that  the stock is trading at +1SD above its five-year historical mean. 
 
- Flaming out. We expect industry cigarette sales volume to come under renewed  pressure  with  the  Government  potentially  raising  the  excise duty  on  tobacco  products  in  the  upcoming  Budget.  This  may  be  further aggravated  by  the  ramp-up  in  its  subsidy  rationalisation  efforts,  as  well as the possible implementation of the goods and services tax (GST).  

- More to lose. We reckon RJR may be challenged by the events above given its stronger exposure to the value-for-money (VFM) market, which contributes >50% of the company’s cigarette sales. There is a higher risk of  smokers  in  this  segment  –  who  are  generally  more  cost-conscious  – trading  down  and  switching  to  illicit  cigarettes.  Thus,  RJR’s financial performance may be more adversely affected if the excise duty is raised. That  said, its  premium  flagship  brand,  Mevius, is fast  gaining  popularity and market share.  Mevius  contributes >25% of the company’s cigarette sales.

- Forecasts  and  risks. We  make  no  changes  to  our  estimates.  The  key risks to our forecasts include: i) a lower-than expected excise duty hike, ii)  stronger  sales  volume,  and  iii)  lower-than-expected  raw  materials costs.

- Investment  case.  We  raise  RJR’s WACC assumption to 9.0%  from 7.4%  after  increasing  our  beta  assumption  to  0.9  from  0.59.  This  is  to better  reflect  its  recent  price  performance  and  a  higher  systematic  risk moving  forward.  We  reduce  our  FV  to  MYR5.72  (WACC:  9.0%,  TG: 1.0%)  from  MYR6.93,  based  on  FCFF  valuation.  Given  rising  bond yields,  we  think  that  companies  that  dish  out  high  dividends  despite limited  growth  opportunities    do  not  deserve  such  high  P/E  valuations  . Hence, we downgrade the stock to a SELL from Neutral.

Source: RHB