British American Tobacco (Malaysia) Bhd
(Oct 5, RM42.70)
Maintain buy with an unchanged target price of RM52.08: British American Tobacco (Malaysia) Bhd’s (BAT) results for the third quarter of financial year 2017 (FY17) are expected to be released on Oct 23. We expect accumulative earnings for the first nine months of FY17 to come in the range of between RM367 million and RM452 million, representing 5.4% growth year-on-year (y-o-y). This is after taking into account the cessation of manufacturing cigarettes locally and the beginning of selling imported cigarettes; as well as other cost-saving initiatives taken by the group.
For Budget 2018, we think there will be no hike in sin tax within the tobacco industry in 2018 as the government would be focusing on combatting the illicit trades, which have led to the drop in tax revenues in the tobacco industry.
Last year, the government collected a revenue of RM3.2 billion from tobacco excise duty. In year 2017, we are estimating that the tax revenue collection to be around RM2.8 billion (-10.0% y-o-y) as the legal industry volume is projected to decline further to seven billion sticks this year. Note that industry volume for the first half of 2017 posted a decline of 10.7% y-o-y to 3.6 billion sticks, despite a stricter enforcement in clamping down illicit trades early this year. Illicit cigarettes’ market share remained stubbornly high at 58% in the second quarter of 2017 (2Q17), a minor drop from an all-time high of 59% in 1Q17. As such, we believe the government’s main objective next year would be bringing down the illicit trades’ market share.
One of the temporary and immediate solutions proposed by BAT and retailers in the industry to mitigate the rise in illicit cigarettes trading is through the reintroduction of smaller-pack cigarettes. Note that the seven- and 10-stick packs of cigarettes were banned in 2006 while the 14-stick pack was banned in 2010. However, re-allowing the smaller packs in the market is gaining strong opposition by the ministry of health and non-profit organisations as this will not address concerns over rising health issues from smoking. Furthermore, Malaysia being a party to World Health Organization’s Framework Convention on Tobacco Control (FCTC) since 2005 is already in line with FCTC’s Article 16, which prohibits the sale of cigarettes individually or in small packets as it increases the affordability of the products to minors. Backtracking the rule will project a negative image on the country on a global scale. As such, we do not expect the government to reintroduce smaller cigarette packs in Budget 2018.
Other than the kiddies pack debate, a local online news site shared that there would be possible introduction of licence for retailers to sell legal cigarettes at their stores. Not surprisingly, this proposal was strongly opposed by the retailers as this would further burden them in terms of costs. Note that the proposal for clear packaging by the government is also on hold due to strong opposition by the tobacco players. All in, we do not expect Budget 2018 to have any significant impact on our earnings projections for 2018, unless there is a sin-tax surprise or reintroduction of small pack cigarettes.
Looking forward, we continue to see a challenging environment and pressure on cigarette manufacturers. To protect market share, we do not expect cigarette manufacturers to raise prices in 2018. BAT is expected to actively promote the Premium brand of Dunhill (RM17 per pack) and the Aspiration Premium of Peter Stuyvesant (RM15.50 per pack) as consumers of these brands are generally less price-sensitive. However, we are projecting BAT sales volume to reduce by 5.4% y-o-y attributable to the intense competitive environment. — TA Research, Oct 5