Cigarette sales to see growth after 8 years?

In The Edge Financial Daily Today 2012

Wednesday, 02 May 2012 14:46

Shares in British American Tobacco (M) Bhd (BAT) have done quite well, giving shareholders gains totalling some 12%, including dividends, YTD. By comparison, the FBM KLCI was up by just about 3% over the same period.

Increased interest in the stock could be due, in part, to the prevailing cautious sentiment. Outlook for the broader market, at least in the near term, is somewhat ambivalent after taking into account uncertainties, both external and domestic. Piling into relatively defensive and high yielding stocks would make sense for the more risk averse investors in the current environment.

The tax reprieve for cigarette manufacturers last year was also a welcome surprise. After hiking duties in each of the previous eight years, the government kept taxes steady in October 2011, when it unveiled Budget 2012.

In the absence of a further price increase and tougher enforcement on minimum pricing, the three large cigarette manufacturers managed to claw back some market share in recent months.

Industry volume sales rose 7.7% in 1Q12 at the expense of demand for exceptionally cheap whites, whose share of the market nearly halved from its peak in 1Q11. The sale of illicit cigarettes also declined, from about 37.3% in 2Q11 to 34.8% in 4Q11. At this pace, we may well see marginal gains in total volume sales for the full year, for the first time since 2003. To be sure, there is still the risk of a tax hike going forward. But for now, the industry is looking to be in better shape.

BAT chalks up strong 1Q12

The improved operating conditions were reflected in BAT’s 1Q12 earnings results. Turnover was up 5.1% y-o-y on the back of the company’s 4.5% increase in volume sales. Operating margins for the quarter also widened after the company outsourced its distributorship in 3Q11. Margin was further lifted by lower marketing expenses due to the timing of brand activities. BAT’s contract manufacturing arrangements also helped defray some fixed overheads.

As a result, net profit increased to RM194.5 million, up 8.9% from 1Q11. After adjusting for one-off gains/losses, the y-o-y earnings increase was even larger at an estimated 21.1%.

Nevertheless, the stock does appear to be fully valued, after recent gains. Its shares are trading at roughly 21.3 times our estimated net profit of RM742 million for the current year.

Assuming a 100% net profit payout, about RM2.60 per share, dividend yields are estimated at 4.7% at the current share price. A first interim dividend, of 65 sen per share was declared. The stock will trade ex-entitlement May 10.

Improved outlook should bode well for JT International Bhd

Positive industry volume growth and BAT’s upbeat 1Q12 earnings should bode well for JT International. In contrast to BAT’s outperformance, the latter’s shares have fared poorly, so far this year, falling by some 6%.

JT International’s earnings last year came in below our forecast. Sales for its value brand cigarettes came under intense competition from BAT, especially after the launch of Peter Stuyvesant in 2010. Volume sales contracted 2.3% in 2011, on par with the industry’s volume decline. By comparison, BAT’s volume declined by a lower 1.3%.

More importantly, investors were disappointed that JT International did not raise its dividends last year despite its mounting cash pile. Net cash increased to nearly RM260 million as at end-2011, up from RM189 million at the previous year-end. The company had been widely expected to return excess cash to shareholders, as it did in 2007, 2008 and 2009.

Given the better operating environment and earnings outlook, it could still do so in the current year. Globally, a growing number of companies are leaning towards higher dividend payout ratios and geared balance sheets amid prevailing low interest rate environment.

In addition to the regular net dividends totalling 22.5 sen per share, we estimate that JT International could afford to pay an additional 60 sen per share, at least, in special dividends this year and still remain in a very comfortable net cash position, even after taking into account slightly higher capital expenditure for the year.

Given that the stock is now trading at comparatively modest 14.3 times our estimated earnings of 48.9 sen per share for 2012, an increase in payout ratio, which averaged only 44% to 48% of net profit in 2010/11, can certainly be expected to support higher valuations.

Note: This report is brought to you by Asia Analytica Sdn Bhd, a licensed investment adviser. Please exercise your own judgment or seek professional advice for your specific investment needs. We are not responsible for your investment decisions. Our shareholders, directors and employees may have positions in any of the stocks mentioned.
This article appeared in The Edge Financial Daily, May 3, 2012.

From theedgemalaysia.com