Consumer (Tobacco) - Neutral - 28 March 2012

Stock Name: BAT
Company Name: BRITISH AMERICAN TOBACCO (M)

Research House: KENANGA

Price Call: HOLD

Target Price: 52.80

We will be separating the tobacco sector from our generalconsumer sector strategy outlook from here onwards. At this juncture, we aremaintaining our NEUTRAL call on the industry. The tobacco industry has beenexperiencing a decline in legal cigarettes volume since 8 years ago in contrastwith the increasing illicit trades. In fact, the absence of any tax hikes inlast Oct has apparently slowed down the booming illicit trades. We however hopethat the government will continue to maintain the tax duties this year and alsocontinue to lend a hand to shape up the legal industry. On top of that, we alsosaw a significant decline of volume in sub-VFM for 2011. This could also be a positiveindication of consumers turning from illicit and sub-VFM to VFM or premium cigarettesas a result of the absence of tax hikes. Nonetheless, the challenges and obstaclesthat the tobacco industry faces remain high with the key challenges being thecontinued uncertainties of future excise duty hikes and the continuing highlevel of illicit trades. As a result, we remain NEUTRAL on the tobacco sector andis reiterating our MARKET PERFORM call on BAT with TP of RM52.80.

50/50 chance of anexcise duty hike this year, hence remains neutral. The absence of a hike inthe sin tax in Budget 2012 last year have given the market a positive surprise andwe believe the TIV would likely stabilise this year, provided there is noadditional hike throughout this year. Historically, the government has nevermissed to increase the tax at least once for the past 8 years and has increasedit out of the Federal Budget for several years since the first time in 2007.Thus, we believe that there is still a 50/50 chance of an additional tax hikethis year especially towards the second half of the year and probably after thegeneral election. We have computed the correlation between tax hikes and TIVand found that it has historically shown an inverse relationship that heldalmost to perfection. In other words, we believe the TIV will be negativelyimpacted if there is any further increase of the tax this year. That said, weremain neutral at this juncture on the back of the absence of any taxadjustment in the last Budget 2012, a diminishing sub-VFM volumes (-16% YoY)and a decrease in the illicit trades (-0.2ppt YoY). 

Expect slightimprovement in 2012 TIV. The booming sales of illicit cigarettes have softenedin 4Q11 by -1.5ppt QoQ and -0.2ppt YoY. However, the quantum of decrease was notas ideal as the performance in 4Q10 (-4.2ppt QoQ and -1.2ppt YoY). Moreover,the current  level  is still  on  the high  side  as compared  to  3 years  ago,  which in  turn  negatively impacts the government tax revenueand at the same time jeopardises the government health agenda to reduce smokingprevalence and also threatens the legal industry such as BAT, JT Internationaland Phillip Morris. In the past two years, the first wave (from Mar to Jun) ofthe illicit tobacco was the highest among the 3 waves. Assuming the trendremains, we hope that the first wave for 2012 would at least be maintained orlesser than the current level of 34.8% for 4Q11 and will continue to decline inthe following two waves. As such, the legal cigarettes would probably make arebound  above 3.0b sticks or slightlyabove 3.5b sticks per quarter. For this year, 2012, we expect the TIV toimprove slightly to 13.4b sticks as compared to 13.3b sticks in 2011. Thebetter expectation is mainly supported again by the absence of any taxadjustment in the last Budget 2012 and also the diminishing sub-VFM and lowerillicit trades. We are also anticipating that the history will repeat itselfand that wave 3 would have a stronger volume than the rest mainly caused by thespeculation of an excise hike after a general election as well as before Budget2013. 

Cloudy days ahead?The challenges and obstacles that  thetobacco industry face remain with the key challenges being the continueduncertainties of future excise duty hikes and the continuing high level ofillicit trades. Thus, we remain NEUTRAL on the tobacco  industry and  reiterate  our MARKET  PERFORM  call on  BAT  with a  TP  of RM52.80. Although we have not included JT International into ouruniverse yet, we believe BAT will catch the most limelight among its peers asits market share is light years ahead of the rest in both the premium and VFMsegments. In addition, it would potentially overtake the VFM market shareleadership this year while maintaining its strong market share in the premium segment. 

 Source: Kenanga