News

• The government has raised the ex-factory pricing of cigarettes, resulting in an increase in the retail price of cigarettes. 
• Hence, BAT has announced a 20 sen increase on the prices of all its cigarette packs effective today, 22 Oct 2012. Comments  Although we were surprised by the timing of the news, it was largely in line with our view that any tax hikes will likely be an off-Budget event. 
• Resulting from the additional 2 sen per stick, brands under the VFM segment have a larger price hike impact of 2.35%, compared to 2% for brands under the premium segment. 
• We believe that BAT’s volume would be affected by this hike albeit marginally, as smokers would opt for a cheaper source of cigarettes. Tracking back its historical trend since 2006, volume declined 0.7% for every 1% hike in its price. 
• Given the headstart from BAT on the price hike, we believe the remaining two tobacco players (JT International, JTI and Philip Morris International, PMI) would follow suit as well. 
• JTI would be hit harder from the hike as VFM segment (which contributes ~60-80% of JTI sales) experiences a higher percentage increase due to its lower base compared to the premium segment. 
• Historically, JTI’s market share has fallen at a larger quantum compared to BAT and we believe there will be downtrading into the cheap whites and/or illicit cigarettes. 
• Industry volume (TIV) continued to decline in 2011 although cigarette prices remained throughout the year. This news further fortifies our view that volume in 2012 would remain in the downward trend. 
• Hence, the definite winner would be the cheap whites and the illicit cigarettes. With that, the level of illicit cigarettes, which currently sits at 36.1%, could claw its way back up after declining for the past two years. 
• Based on historical statistics, the increase in illicits has outgrown the increase in cigarette prices. Hence, we opined that both tobacco players and the government should keep an eye closely on the level of illicits to prevent them from growing further.

Risks

• Exceptionally higher ED hike. 
• Increase in illicit trade volume. 
• Weaker-than-expected TIV. 
• Regulation tightening.

Rating

NEUTRAL
 

• Positives – (1) High dividend yield stocks; (2) Countercyclical share price pattern; (3) Oligopoly industry; and (4) Resilient earnings and low capex requirements. 
• Negatives – (1) Highly regulated industry; (2) Potential ED hike; (3) High level of illicit cigarettes in the market; and (4) Prices already reflect fundamentals

Valuation

We are not changing our forecasts for now, pending more information obtained on this matter. Maintain our NEUTRAL stance on the sector, and HOLD on JTI (TP: RM7.18) and BAT (TP: RM53.10)

Source: Hong Leong Investment Bank Research - 22 Oct 2012