British American Tobacco (M) Bhd
(June 29, RM60.86)
Upgrade to buy with a target price (TP) of RM72.82: BAT raised the prices of all its cigarette brands by 30 sen from yesterday. According to management, the price hike is due to the goods and services tax (GST). We are upgrading our stance to “buy” with an unchanged TP of RM72.82 per share.

The brands involved in the price hike are Dunhill, Kent, Benson & Hedges, Lucky Strike Plain, Pall Mall, and Peter Stuyvesant. This was announced by BAT in a statement on Sunday for price increases of its premium and sub-premium cigarettes.

According to management, the main reason for the price hike is to take into account the GST as the company has been absorbing it for the past three months (April to June). This represents an increase of 2.5% to 2.1% on its previous prices.

We expect the price hike to slightly impact its earnings for 2015 due to the possibility of a drop in near-term volume to competitors. As such, we revise revenue and earnings for FY15 downwards by 1.1% and 3.4% to factor in the above. 

However, we expect this price hike coupled with the strong enforcement against illicit cigarettes by the Royal Malaysian Customs to enable the volume to rebound in due course. 

Due to the implementation of the GST, BAT has been absorbing the cost which might have impacted its earnings in the second quarter ended June 30 of financial year 2015. However, with the increase in price, we expect BAT to be able to obtain the lost profit as well as to eventually recover the expected loss in volume. 

Pursuant to the recent price weakness, we are upgrading our stance to “buy” with a TP of RM72.82 per share. Our valuation is derived from the dividend discount model with a cost of equity of 6.5%. — MIDF Research, June 29

This article first appeared in The Edge Financial Daily, on June 30, 2015.