British American Tobacco (Malaysia) Bhd
(April 14, RM68.80)
Maintain hold with lowered target price (TP) of RM70.10. We reiterate our hold recommendation on British American Tobacco (Malaysia) (BAT) with a slightly lower discounted cash flow-derived fair value of RM70.10 per share, which implies a financial year 2015 forecast (FY15F) of price-earnings (PER) of 21 times. We understand that BAT has reduced the prices of all its cigarette brands by 20 sen a pack (-1.4% to -1.6%). The retail selling price (RSP) for each pack of 20 is now RM13.80 for the premiums, i.e. Dunhill, and RM12.30 for the aspirational premium labels, namely Pall Mall and Peter Stuyvesant.

This reduction came as a surprise given that BAT had only recently (on April 1) increased prices of all its brands by 50 sen a pack (+3.7% to +4.1%). The rationale it cited for the increase was the government’s implementation of the goods and services tax (GST) of 6%.

While the oligopolistic nature of the industry means that price adjustments are usually made in unison (with BAT the price leader given its dominant position with a 61% market share), recent trends have shown that this is no longer the case.

In this latest round of price adjustments, Philip Morris International (PMI) had increased its cigarette prices by a lower 40 sen a pack, while JT International (JTI) had opted to maintain prices.

We believe that the pricing decisions by its peers may have led BAT to lower the quantum of its hike. The cigarette manufacturers now appear to be competing on price to capture a larger share of the shrinking legal total industry volume (TIV) pie (FY14: -4.4%). The last known price war was in 2007, which is before the introduction of a minimum RSP (2010) and prohibition of price discounting (2012).

We note that this is also the second time that BAT has qualified its price hike announcement. Recall that in September 2014, it reversed its RM1 a pack hike as PMI did not follow suit. Its earlier decision had resulted in its volumes declining 1.9% quarter-on-quarter.

While we do not believe that its volumes will be as negatively impacted given the smaller differential this time, we assume that BAT could have lost some market share to PMI, given its premium-skewed mix, and to JTI due to downtrading activities and the latter’s status quo prices.

All in, we have tweaked our FY15F to FY16F earnings estimates lower by 1% to 2% after incorporating the new RSP and year-on-year legal TIV declines of -7% and -4.5% (versus -8% and -5%, previously). Bearing in mind the government’s Price Control and Anti-Profiteering Act 2011, BAT could now be absorbing a larger portion of the GST. This could be detrimental to its margins. We have thus assumed an earnings before interest, taxes, depreciation and amortisation margin contraction of some 0.5 percentage point.

Valuation-wise, BAT is currently trading at a FY15F PER of 21 times with yields of 4.8%. — AmResearch, April 14

This article first appeared in The Edge Financial Daily, on April 15, 2015.