Impending cigarette price rise weighs on BAT’s shares

BAT shares fell for 2 straight days after MoH’s announcement that retail cigarette prices will be raised by end-Oct


British American Tobacco (M) Bhd’s (BAT) share price dropped due to the expected cigarette price increase later this month despite the absence of exact pricing structure for the product.

BAT shares fell for two straight days after Health Minister Datuk Seri Dr Dzulkefly Ahmad announced recently that retail cigarette prices would be raised by the end of October.

The increase is in line with the Sales and Services Tax (SST) implementation last month. The introduction of SST had prompted tobacco companies BAT, JT International Bhd and Philip Morris (M) Sdn Bhd to raise prices by 20 sen to 50 sen per pack. Profits at these cigarette makers have taken a heavy beating due to illicit cigarettes.

Hong Leong Investment Bank Bhd analyst Gan Huan Wen said BAT’s profitability is contingent of the illicit market volume which is at risk of rising if retail cigarette prices are increased.

“Should the government require cigarette players to raise prices, we expect legal market volumes to be crippled by the rampant illicit trade due to the already huge price differential between legal and illegal brands,” Gan said in a report yesterday.

Consequently, the research firm downgraded BAT to a ‘Hold’ with a lower target price (TP) of RM32.80 — down 11.3% from the previous TP of RM37 — based on a discounted cashflow (DCF) valuation. It also raised the company’s weighted average cost of capital to 8.4% from 8.2%.

Illegal cigarettes command about 63% of the total consumption in Malaysia, largely due to the wide price difference between illicit (typically priced at RM4 to RM5 per pack) and legal brands.

The new price structure will exert additional pressure on the legal tobacco industry, which has yet to recover from the 40% excise duty hike in November 2015.

BAT remains the leader in Malaysia’s shrinking legal cigarette market, selling about 5.3 billion sticks over the first nine months of this year.

TA Securities Holdings Bhd analyst Damia Othman said BAT’s management indicated that demand is expected to be stable if cigarette prices are increased by only 50 sen a pack — reflective of the SST amount to be passed on to consumers.

“Illicit cigarettes trades continue to be the main threat to the tobacco industry as it has been stagnant at 63% of tobacco market share in Malaysia since the fourth quarter of 2017,” she said in a report yesterday.

“We maintain our ‘Sell’ call with unchanged TP of RM27.39 per share based on a DCF valuation due to expectations of lower legal cigarettes demand, post the increase in cigarette prices and the stubbornly high illicit trades.”

MIDF Amanah Investment Bank Bhd maintained a ‘Buy’ call on BAT due to its impro-ving margins internally and the growth of its value-for-money (VFM) product Rothmans.

“We opine that while the business environment will continue to remain challenging, we are comforted by the fact that BAT’s VFM brand Rothmans remains the fastest growing brand, which we opine will assist in sustaining its position as a market leader in the legal cigarettes domain.

“Additionally, the revenue and volume contraction has narrowed to low single digits from low double digits earlier this year and the previous financial year.”

The research firm said this is mainly attributable to the company’s ongoing cost rationalisation, which bolstered earnings and profit margins over the recent quarters.

It maintained BAT’s TP at RM37.70 based on a dividend discount model valuation with a cost of equity of 6.5% and long-term dividend growth of 1.25%.

After the change in government in May this year, BAT shares recovered from a record low of RM22.46 on May 7 — two days before polling day — to as high as RM37.20 on Aug 23.

This was driven by renewed optimism on the sector as the newly elected government sought to continue the fight against illicit cigarette consumption, while reducing the cost of goods nationwide.

However, the lack of clarity surrounding the SST structure remained a key downside risk to tobacco players.

The announcement by the health minister that retail cigarette prices are to increase by the end of October was enough to send many investors fleeing.

BAT shares closed RM1.02 lower at RM31 yesterday. This represents a loss of approximately RM1.77 billion in market capitalisation since the August high.