BAT expected to continue to face challenges from illicit trade

This article first appeared in The Edge Financial Daily, on January 22, 2018.
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British American Tobacco (Malaysia) Bhd
(Jan 19, RM33)
Maintain hold with a target price (TP) of RM 40.90:
According to a report quoting Bernama last Friday, Health Minister Datuk Seri S Subramaniam maintained that the Malaysian government will not support the proposal to reintroduce kiddie packs (pack of 10 cigarettes). He also highlighted that if this proposal was approved, it would be against the National Tobacco Policy and Article 8 of the World Health Organisation’s Framework Convention on Tobacco Control (FCTC).

Tobacco companies in Malaysia, including British American Tobacco (Malaysia) Bhd (BAT), on Sep 6, 2017 proposed to the government the reintroduction of smaller cigarette packs. Their aim was to increase legal cigarettes sales by cutting down on illicit volumes, while boosting government’s revenue from tobacco tax. Smaller packs of cigarettes were available at seven, 10, and 14 sticks before they were banned by the health ministry in 2010. The rationale for a smaller cigarette pack is to provide consumers a cheaper legal option by increasing the affordability of a pack of cigarettes. As at Aug 2017, BAT reported that illicit sales formed 56.1% of the market’s total sales volume, a sharp increase from 36.3% in 2010. BAT is confident the introduction of kiddie packs, coupled with better enforcement efforts to clamp down on illicit trade, could result in illicit volumes declining by 55% over the next three years. We expect the illicit trade to remain a thorn in legal sales volume, given that consumer spending remains weak at this juncture.

Previously, we estimated that the reintroduction of a 10-stick pack could increase BAT’s earnings by 14.2% to 17.8% in the finanial year 2018 (FY18) to FY19 period through a 15% to 20% increase in volume. However, we did not factor in any earnings contribution from the sales of any kiddie pack pending updates on this matter. 

We make no changes to our “hold” call and discount dividend model (DDM)-based TP of RM40.90 pending the release of BAT’s full-year FY17 results and its response to this matter. Although we believe BAT’s earnings prospects are slated to improve in 2018 from lower illicit trade and higher sales volume, we would only turn more positive when it registers more significant improvement in sales volume. 

Downside/upside risks include stronger/weaker-than-expected sales volume and changes to excise duties. — CIMB Research, Jan 18