This article first appeared in The Edge Financial Daily on September 25, 2018

British American Tobacco (M) Bhd
(Sept 24, RM33.40)
Maintain buy with an unchanged target price (TP) of RM37: Last Friday, an article in The Edge Financial Daily stated that British American Tobacco (M) Bhd (BAT) has decided to revert shelf prices back to pre-sales and services tax (SST) prices.

Based on our channel checks, Dunhill, Benson & Hedges and Kent have been reduced from RM17.50 back to RM17, Pall Mall from RM16 to RM15.50 and Rothmans from RM12.50 to RM12. Additionally, Philip Morris (M) Sdn Bhd has also scaled back their initial 50 sen price increment to 20 sen (Marlboro Golds’ shelf prices, increased to RM17.50 from RM17, have been reduced to RM17.20). To recap, BAT, JTI International Bhd and Philip Morris raised prices at the onset of the SST.

At this juncture, it is uncertain if the price rollback will be permanent as a BAT spokesman commented: “Given the market situation as we see it today and the non-clarity of when the tax approach would be resolved, we have decided to revert to our original prices while waiting for guidance from the ministry of health.” However, in the event that BAT and other tobacco players choose to raise shelf prices, we expect the illicit market to grow even more rampant, given the price differential between illicit cigarettes (a pack of 20 sticks costs under RM5) and those in the legal market.

BAT’s market share of the total legal market was 57.8% in the first six months of 2018 (6MCY18) (up from 56.5% in 6MCY17). Crucially, Dunhill grew year to date to 40.3% of the total legal market from 40%. Dunhill’s value-for-money brand ‘Rothmans’, launched late last year, made up 3.3% of the legal market in the first half of 2018. Currently, the illicit market appears to have stabilised at 63% of total industry volume.

The “zerorisation” of the goods and services tax (GST) from June 1 to Aug 31, 2018 should lead to better margins in BAT’s third quarter ending Sept 30, 2018 (3QFY18) as BAT was not permitted to lower shelf prices during this period. Additionally, BAT is optimistic that the newly elected government will increase efforts to curb the illicit market. Pakatan Harapan’s alternative 2018 budget states the newly elected government intends to collect RM6.1 billion in cigarette excise duty versus RM3.5 billion estimated by the previous administration.

We expect the new government to step up efforts to curb the illicit cigarette trade, in turn boosting legal market volumes, and hence increasing excise duty tax collection to partially fill the tax gap from the GST to SST migration. We maintain our earnings forecasts as we are uncertain if the price rollback is permanent. We maintain our discounted cash flow-based TP of RM37, “buy” call with weighted average cost of capital of 8.2% and terminal growth rate of 3%. — Hong Leong Investment Bank Research, Sept 24