British American Tobacco (M) Berhad - How will BAT Malaysia benefit from Myanmar deal?

29/7/2013 – Alliance Research continues to view the tobacco sector negatively as it believes there are more headwinds ahead.

This includes the potential hefty excise duty hike. The resulting spike in cigarette prices will likely lead to an increase in illicit trade.

Hence, it reiterated its SELL call on BAT with a target price of RM54.72.

Separately, British American Tobacco PLC (BAT) says it is re-entering Myanmar, 10 years after leaving the country.

BAT is going back to Myanmar via a joint venture with I.M.U. Enterprise Ltd to manufacture, to distribute and market its brands for the domestic market.

IMU is part of the Sein Wut Hmon Group, which has an extensive fast-moving consumer goods distribution network throughout the country.

Myanmar is the 6th heaviest smoking country in ASEAN, with 23.1% of its population using tobacco products, as per statistics provided by the South East Asia Tobacco Control Alliance last May.

BAT will invest US$50 mln over five years in a world-class manufacturing facility in Shwe Than Lwin Industrial Zone in Yangon's Hlaing Tharya township.

This plant will produce its London brand of cigarettes.

It will employ 400 people to begin with, and also intends to collaborate with local farmers to improve their yield and quality of local tobacco.

The company left Myanmar in 2003 following a campaign against it over its links with the military.

Investor Central. Asian insights for global investors. We ask the tough questions of Asian companies which global investors need answers to.

Question

1. How will BAT Malaysia benefit from Myanmar deal?

Remember, the joint venture in Myanmar is between BAT's UK parent company, not Bursa-listed BAT Malaysia.

But BAT Malaysia is currently undertaking export contract manufacturing for other BAT PLC companies in Asia Pacific.

So, the question is whether the output of the new factory is sufficient for the Myanmar market, and therefore whether there will be any order flow to BAT Malaysia.

In FY12, BAT's contract manufacturing operations saw a 17% growth in contract manufacturing of cigarettes and a 66% growth in processed tobacco (which is ready to be included in cigarettes and filter rods).

Question

2. What are the proportions of the joint venture?

Maybe we missed it, but we couldn't find anything that would tell us what the share proportions are.

Question

3. What military ties does its new joint venture partner have?

The company left Myanmar in 2003 following a campaign against it over its links to the military.

It sold its share of Rothmans of Pall Mall Myanmar to Singapore's Distinction Investment Holdings after receiving what was described as an "exceptional request" from the British government to leave Myanmar.

It had owned 60% of Rothmans of Pall Mall Myanmar, with the remainder held by military-backed Union of Myanmar Economic Holdings.

This link to the military made it the target of fierce lobbying by Burma Campaign UK and the Federation of Trade Unions in Burma, which marked BAT's withdrawal from Myanmar as a major victory.

Instrumental in the decision was former British Prime Minister Tony Blair and Conservative MP and former Deputy Chairman of BAT, Ken Clark.

Question

4. Can BAT advertise tobacco in Myanmar?

Myanmar banned advertisements of cigarette and liquor in 2008, warning that such advertisement billboards erected in the Yangon municipal area would be removed.

The area is about an hour from the planned manufacturing production facility in Shwe Than Lwin Industrial Zone in Yangon's Hlaing Tharya township.

What impact will this ban have on demand?

Question

5. How much trouble does BAT foresee from the new Health Minister's initiatives in Malaysia?

The new Minister of Health Ministry, Datuk Seri Dr S. Subramaniam announced last month that with effective from 1 Jan 2014, the maximum allowable tar per cigarette would be cut from 20mg to 15mg, and nicotine content from 1.5mg to 1.25mg.

By June 2015, tar and nicotine content per cigarette will be further reduced to 10mg and 1mg respectively.

Apart from that, the minister also revealed that the ministry will review whether cigarette boxes at convenience stores constitute "indirect promotion of cigarette brands", which is prohibited under the Control of Tobacco Regulation 2004.

Going forward, the ministry indicated that it will implement more stringent enforcement, including reviewing the promotional activities by tobacco companies, such as the use of pretty counter girls to attract consumers to buy cigarettes, and tightening the definition of smoke-free buildings to include covered areas as non-smoking zones.

Question

6. What is BAT's view of how its business will be affected by a ban on e-cigarettes?

E-cigarettes are electronic inhalers that vaporise liquid nicotine into mist, simulating the act of tobacco smoking.

They are often made to look like cigarettes, pens and pipes.

They are becoming popular in Malaysia among youths due to the various flavourings used in the nicotine. There is also currently no age limit imposed on the sale of e-cigarettes.

The Consumer Association of Penang (CAP) has pushed for a ban on e-cigarettes.

But the health ministry is waiting for more scientific evidence before making a decision to ban or regulate shisha and e-cigarettes.

According to AMMB, an outright ban on e-cigarettes would be mildly positive for local cigarette volumes which have been on the decline following the proliferation of illicit white cigarettes, price hikes last October and June and the sale of cigarettes below the minimum price.

What is BAT's view of how its business will be affected by a ban on e-cigarettes?

Question

7. Will 3% increase in price affect its sales volume?

BAT announced a 30 sen price increase per pack of cigarette with effect from 3 June 2013.

According to the management, the 3% price hike is mainly to take into account inflationary pressures, higher labour and input costs which resulting in rising operating costs over time.

In addition, BAT claims that the legal tobacco industry volume has also been affected by continuing high level of illicit trade.

Question

8. Will it further increase the price of cigarettes post Budget 2014?

Given that only 50% of the proposals have now been confirmed to be included in the Control of Tobacco Regulation 2004, it may mean that more bad news for tobacco manufacturers may come.

Alliance Research estimates a hefty excise duty hike of RM0.50 per pack will be in the upcoming Budget 2014.

This could increase the cigarette price from the current RM10.50 per pack, post BAT price increase, to RM11.00 per pack.

We have sent these questions to the company to invite them for an on-camera interview, and/or seek their written response.

We thank BAT for replying with a phone call, even if they couldn't provide answers to our questions.

Most of our questions concern BAT's UK parent company, which is why they can't answer them.

BAT referred questions about e-cigarettes to the Health Ministry and said that naturally they would comply with any laws.

The 3% price increase may impact volumes a little, but it won't be a big impact. Besides, it's too early to tell.

We thank BAT for their responses.


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