Equity Analysis /
Sri Lanka

Ceylon Tobacco: 2Q CY22 - Lower end products to mitigate volume impact in 2H

  • Volumes up QoQ in 2Q; price increases to offset volume pressure in 2H

  • EBIT margins to improve significantly in 2H as FX impact stabilises

  • We use a 3-stage DCF model and arrive at a fair value of LKR 860.00/share

Asia Securities
27 September 2022
Published byAsia Securities

We use a 3-stage DCF model and arrive at a fair value of LKR 860.00/share (+23.8% upside; +37.5% TSR). CTC reported an EPS of 17.94 for 2Q CY22 down 19.7% QoQ (-14.2% YoY). Revenues of LKR 10.1bn were up 10.7% QoQ (+31.6% YoY); we forecast further revenue growth in 2H CY22E as recent price increases offset a decline in volumes. EBIT margins were down sharply by 9.7pp QoQ (-19.0pp YoY) due to FX losses taken on revaluation of foreign currency payables. With currency stabilisation, we expect a sharp improvement in EBIT margins during 3Q CY22E. CTC trades at a discount to its 5-year P/E multiple average; we rate BUY.

Volumes up QoQ in 2Q; price increases to offset volume pressure in 2H

Revenues of LKR 10.1bn were up 10.7% QoQ (+31.6% YoY). Following a 6.3% QoQ reduction in 1Q, volumes were up 0.8% QoQ in 2Q CY22. We believe the volume pickup was partly due to stockpiling by traders ahead of the Aug 2022 interim budget. However, CTC has also 1) taken significant price reductions on lower end products and 2) introduced mid-range products at more affordable price points. These measures have provided consumers with cheaper options, lessening the potential decline in volumes due to cost-of-living pressures. CTC noted that its flagship product John Player Gold Leaf has seen volumes decline to approx. 51.0% of total sales (approx. 65.0% in CY21) while lower end Capstan volumes have almost doubled. CTC has taken further price increases following the interim budget in Aug 2022. The impact of these price increases was highest for lower end products; as such, we expect some pressure on volumes in 2H CY22E. We forecast revenues of LKR 41.6bn for CY22E up 23.6% YoY.

EBIT margins to improve significantly in 2H as FX impact stabilises

EBIT margins of 62.2% were down 9.7pp QoQ (-19.0pp YoY). The significant decline was due to FX losses on foreign currency payables. As such, with the currency having stabilised, we expect a sharp improvement in EBIT margins during 3Q CY22E. Looking ahead, the main impact of currency depreciation will be on imported raw material costs. Raw material costs were up 0.5pp QoQ as a % of revenues; we conservatively expect additional cost pressure in 3Q CY22E. However, following price increases taken in Jun 2022 and Sep 2022, we believe CTC would have passed on these cost increases in order to safeguard margins.

We use a 3-stage DCF model and arrive at a fair value of LKR 860.00/share

In CY22E, we expect 1) further price increases together with 2) inelastic demand for cigarettes to result in revenue expansion. Further, our analysis indicates that CTC’s earnings have historically displayed a positive correlation with inflation. CTC faces a strong likelihood of further tax increases through the upcoming budget; however, we believe these will impact indirect taxes in line with measures taken during 1H CY22. We do not expect an increase in CTC’s corporate tax rate. We use a 3-stage DCF valuation to reflect the uncertain macro environment and arrive at a fair value of LKR 860.00/share (+23.8% upside; +37.5% TSR). This target price corresponds to an implied P/E multiple of 9.0x CY22E EPS, at a discount to CTC’s 5-year P/E multiple average of 12.1x. BUY. Key risks: 1) prolonged recovery in spending, 2) delayed pickup in tourism and agriculture and 3) further steep currency depreciation.