Equity Analysis /
Sri Lanka

Ceylon Tobacco: Volumes to recover, risk of duty revision remains; revise TP

    Asia Securities
    29 November 2019
    Published byAsia Securities

    With a boost to consumer spending, we expect a demand recovery for CTC products. On a positive note, as disposable income increases, consumers prefer to switch to legal and branded products. In addition to the impact from PAYE tax revisions, we believe that the proposed removal of NBT and the VAT reduction could also considerably reduce the tax burden for CTC. Currently, c75.0% of the gross revenues are paid as taxes which include excise duties, VAT and NBT. Given that there has been no explanation of the mechanics of implementing the tax revision, we do not take these savings into our estimates. However, should they pass through as proposed, we expect further EPS improvement in CY 20e. However, our key concern remains a further revision to excise duties through 2020 budget reading expected in March. An adverse revision would essentially set off the potential volume gains through a spending recovery.

    Direct tax revision could result in a cLKR5/stick reduction in selling prices

    CTC’s most popular brand John Player Gold Leaf (JPGL) is currently priced at LKR65/stick, up from LKR55/stick early last year. As a result, there has been a gradual decline in volumes, as consumers either reduced consumption or switched to cheaper alternatives. However, should the proposed direct tax revisions pass through, our calculations show that CTC could reduce prices by ~LKR 5/stick across its product range. This we believe will be an additional boost to volumes. In addition, we believe this could also bring down the prices of Navy Cut and Bristol which saw a notable price increase in July 2019 due to the excise duty increase for shorter-length cigarettes. However, as noted earlier, a potential negative excise duty revision in March 2020 could result in setting off the gains from the VAT and NBT revisions.

    We revise our target price to LKR1,385/share and maintain our Buy recommendation

    The stock is down 19.0% YTD and 18.0% yoy and is currently trading at 10.4x our CY 20e estimates. This is a c19.0% discount to its 3-year trading average. With expectation for stronger demand in CY20E as a result of a spending recovery, our discounted cash flow valuation-based target price moves to LKR1,385/share (previously LKR 1,360/share). Including a CY 20e dividend of LKR 87.00 (div. yield of 7.6%), we expect a total return of 28.0%. Buy.