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This article first appeared in The Edge Financial Daily, on March 17, 2016.

 

bat_fd_170316

British American Tobacco (Malaysia) Bhd
(March 16, RM55.04)
Maintain sell with unchanged target price (TP) of RM56.
The recent price hike in November was driven by the substantial increase of 12 sen per stick in the excise duty. The increase was four times higher if we compare with the previous hikes of three sen per stick in 2013 and 2014. As such, British American Tobacco (Malaysia) Bhd (BAT) increased its retail selling price by 16 sen per stick across its brands, including sub-premium brands, to compensate for the decline in volume and protect its margins. 

BAT_chart_fd_170316

However, the ratio between BAT’s selling price increase and the hike in the excise duty is only 1.3 times, which is lower compared with 2.5 times in 2013 and 2014. We believe this is to accommodate weak consumer spending due to the current high debt-to-GDP (gross domestic product) ratio, which is constraining discretionary income and the risk of down trading.   

Domestically, the group manufactured 8.2 billion sticks in financial year 2014 (FY14) and 7.2 billion sticks in FY15, a decline of 13%. Over the past three years, for every one sen per stick hike in BAT’s selling price, its domestic volume contracted by an average of 121 million sticks per year. We attribute the volume drop to the migration to the illicit market. From June to August last year, the volume of illicit cigarettes increased 0.2 percentage point quarter-on-quarter. This suggests that consumers are substituting legal cigarettes with cheaper alternatives (RM4 to RM5 per pack). 

Moving forward, we believe the government will continue to increase excise duty. This is supported by the World Health Organization Framework Convention on Tobacco Control, which seeks an excise duty on cigarettes to be 70% of retail price. Currently, the excise duty is 47% of the current selling price.

The government is planning to introduce plain packaging for all tobacco products. Generic or plain packaging requires manufacturers to print only the brand name, in addition to health warnings and toxic constituents, among others. At the moment, Australia is the only country implementing plain tobacco packaging. 

The government is also looking to impose a smoking ban in all hotels nationwide by the end of the year, with the ban expanded to include other public areas such as recreational parks, restaurants without air conditioners, and ultimately all public areas by 2020. With these restrictions, we believe that contraction in volume is inevitable.

Future earnings are expected to contract by an average of 2.1% over the next three years. This would likely take away valuation support and render the stock less attractive when compared to other high-yielding consumer stocks in our view.

We maintain our revenue forecasts of -3.5%/5.6%/1.5% for FY16/FY17/FY18 respectively, assuming a sales volume decline of -14.4%/-7.9%/-4.9% in the same periods. We reiterate our “sell” recommendation on the stock with unchanged TP of RM56. — TA Securities, March 16

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