This article first appeared in The Edge Financial Daily on November 8, 2018

British American Tobacco (Malaysia) Bhd
(Nov 7, RM36.22)
Maintain hold with a higher target price (TP) of RM32.77: British American Tobacco (Malaysia) Bhd’s (BAT) sales and service tax (SST)-induced hike of 40 sen per pack for all pricing categories took effect last Friday. This has raised its selling prices by 2.4% to 3.3%.

We cut our financial year 2018 forecast (FY18F) and FY19F earnings per share (EPS) forecasts by 0.5% and 2.2% as we expect margins to narrow once the lower-value brand Rothmans builds up scale.

Effective last Friday, BAT raised the retail prices of all its cigarette products by 40 sen per pack to take into account the 10% SST. The new prices per pack are at RM17.40 for Dunhill and Kent (+2.4%), RM15.19 for Peter Stuyvesant and Pall Mall (+2.6%), and RM 12.40 for Rothmans (+3.3%).

It last raised prices on Sept 4 by 50 sen, only to reverse its decisions on Sept 21.

During the tabling of the Budget 2019 last Friday, Finance Minister Lim Guan Eng said the government aims to recoup at least RM1 billion per year in excise duty lost to the counterfeit cigarette trade.

Guan Eng reiterated the government’s pledge to enhance the enforcement of laws against smuggling. An extra RM1 billion worth of excise duty collection is equivalent to a reduction of 2.5 billion sticks in the illicit trade, whose market share stood at 62% as at September 2018.

We are overall neutral on this latest development. The 40 sen per pack hike is 10 sen lower than what we previously assumed, which may not signifacntly affect the premium’s and aspirational premium’s volumes.

However, we expect that the potential growth to be mostly driven by the value-for-money (VFM) brand Rothmans, whose lower trade value is likely to dilute the group’s margins. It would take a significant jump in Rothmans’ sales volume to make up for the margin erosion.

We cut our FY18F and FY19F EPS forecasts by 0.5% and 2.2% as we assume higher sales from Rothmans. We revise our FY19F and FY20F sales volume assumptions for Rothmans by 900 million and one billion sticks, which are less than half of the government’s target of a 2.5 billion-stick reduction in illicit cigarette sales per anum.

But our FY20F EPS forecast inches higher by 0.8%, as we expect Rothmans’ sales volume to be sufficient to compensate for its lower margin.

We maintain our “hold” call on BAT. Our dividend discount model-based TP is raised to RM32.77 from RM32.22, after taking into account our EPS changes.

The early stages of pickup in the VFM segment’s volume may risk diluting BAT’s margins.  — CGSCIMB Research, Nov 6