Market Outlook 2017: Cigarettes sector

Rebound of sales volume

National cigarettes sales volume growth reached its slowest pace in 2015 where sales volume in 2015 was on the same level as in 2014. However, sales volume has started to grow in 2016 where as of 1H16 sales volume grew by 0.3% in 1H16. On QoQ basis in 2Q16, sales volume accelerated by 13.4% QoQ and 6.4% YoY. We can somewhat attribute the volume rebound to better economic growth in 2016 in the mid of lower inflation (thus better purchasing power) and reasonable excise tax increase in 2016 by 11.2% (about the same level as nominal GDP growth). In 2017, we expect cigarettes sales volume growth to rebound by 2% with better purchasing power.

Excise tax in 2017

One of the most pressing questions every single year in cigarettes industry is the amount of excise tax increase. The government has enacted that the average of excise tax increase in 2017 is 10.5%, lower than in 2016 of 11.2%. This is good news for cigarettes players as excise tax is significant part of cost structure. The amount of the excise tax is subject to government’s need to fund the budget while keeping the industry afloat. Successful tax amnesty program in 2016 is a boon for cigarettes industry as the government did not have to implement excessive excise tax increase in 2017.

Our top picks

We pick GGRM as our top pick as the company’s market valuation of 16.6x PER 2017 is still much lower than HMSP’s 2017 PER of 31.7x. We acknowledge that HMSP’s historically high dividend payout ratio can somewhat justify high PER but we see that the gap between HMSP and GGRM valuation is still excessive as GGRM’s long term growth (assuming oligopolistic nature of stable market share) would not be much different than HMSP’s long term growth. One can argue that perceived risk also plays a role in determination of justified PER, but given the fact that both of the company is well established company with strong cash flow generation and low debt, both have rather similar risk profile in our view.