- We reiterate our HOLD recommendation on British American Tobacco (M) (BAT) with an unchanged DCF-based fair value of RM62.00/share.

- BAT had, over the weekend, announced that it would raise the prices of all its cigarette brands effective 30 September 2013. Following our channel checks, we now affirm the across-theboard price hike to be RM1.50/pack of 20s.

- The retail selling price (RSP) for the group’s premium brands, namely Dunhill and Kent, is now RM12.00/pack (+14%) while its aspirational premium (VFM) labels, which include Pall Mall and Peter Stuyvesant, will be sold at RM10.50/pack (+17%).

- According to the group’s press statement, the sharp price hike (third in the past year alone) is the result of a 14% (or 3 sen/stick) increase in excise duty to 25 sen/stick.

- While we are not surprised by the government’s move to raise the excise duty, we are taken aback by the quantum of the corresponding price jump. Nevertheless, cigarette manufacturers typically take the opportunity to shore up margins by passing down a higher quantum than the additional tax-led costs to compensate for shrinking sales volume.

- A breakdown of the price increase shows that excise dutyrelated price accounted for only 42% of total increase this time, much lower than 90% in 2010 and 70% in 2009. Historically the ratio of price increase to excise increase for a 3 sen/stick excise hike was ~1.3x (current: 2.5x).

- In adjusting the prices, we suppose that BAT has taken cue from previous price hikes that were deemed inadequate in hindsight. EBIT margins for BAT declined during 2004 to 2011 as price increases of ~6% were outweighed by sharp contractions in legitimate total industry volume (TIV) (2004-2011 CAGR: -5.6%).

- In view of the negative correlation between legal TIV and RSP, we have lowered our legitimate TIV growth assumption to -5% for FY13F and -6% for FY14F. The sudden RSP increase may spur the growth of illicit whites, (May 2013: 23%) and accelerate the proliferation of ELPCs (2.3% share of market).

- Nonetheless, we believe the negative impact from a volume decline will be more than offset by the higher RSP and thus forecast EBIT margins to expand by 1-2ppts in FY13F-FY14F. In addition, BAT intends to ramp up its contract manufacturing deals (~10% of group revenue).

- These translate into a negligible (+0.5%) impact on BAT’s FY13F-FY14F earnings. Yields are still decent at ~4.3%-4.6% for FY13F-FY14F.

Source: AmeSecurities