News

• A local newspaper reported that the governments has been urged through the views received by the Health Ministry to increase the minimum price for a pack of 20s cigarettes to RM20 from the present RM7. 
• It has also been asked to compel manufacturers and importers to reduce nicotine and tar levels to between 1mg to 10mg from the current levels of between 1.5mg to 20mg per stick. 
• Public also wants the ministry to impose a ruling for all tobacco companies and importers to increase the size of imprint pictures of ill-effects of smoking on cigarette packs from 40% to 70%. Other suggestions include banning smoking in public areas.

Comments

• We think that it is unlikely for the government to apply such punitive price hike given several reasons. 
• Government has just recently increased the minimum price per pack of 20s to RM7 in September this year. 
• The 1.96-2.3x in price hike would definitely jeopardise the cigarettes volume in the legal market and cause a sharp hike in illicit. 
• Illicit cigarettes reading have increased again after declining for the past 2 years, hence we opined that the government will be looking at this matter closely and would take precaution steps to curb the illicit volume from increasing further. 
• As for tobacco players, the sharp price hike could be positive for them from higher selling prices with lower raw material costs (from lower nicotine and tar levels per stick). 
• However, they will also lose out as percentage volume would drop significantly as a larger pie of smokers would immediately seek for cheaper cigarettes, especially from the illegal market. The implication would have a larger impact on VFM-segment players, specifically on JTI.

Risks

• Exceptionally high excise duty hike.
• Increase in illicit trade volume.
• Weaker-than-expected TIV.
• Regulation tightening.

Rating

UNDERWEIGHT


• 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

• No changes made to our forecasts. However, we are downgrading the sector to UNDERWEIGHT following the recent downgrade in BAT to SELL with TP of RM52.42. JTI remained a HOLD with TP of RM7.18. While we opine that the above is unlikely to materialise, the news is likely to adversely affect sentiment on the sector.

Source: Hong Leong Investment Bank Research - 09 Nov 2012