Equity Analysis /
Sri Lanka

Ceylon Tobacco: Volume pressure continues; cost management to aid margins

    Asia Securities
    23 May 2019
    Published by

    CTC reported a 1Q CY19 recurring net profit of LKR ~4.1bn (+8.7% YoY) with net revenues up 3.3% YoY and EBIT margins of 76.7% (+3.8pp YoY). Topline was driven by price and lower levies paid to the government. Domestic volumes were down 14.9% YoY for the quarter due to the excise duty hike in March 2019. On a positive note however, CTC noted that there is a switch to cheaper CTC products such as Navy Cut, while there was also a growth in premium brands. With lower COGS due to local sourcing and lower operational costs, EBIT was up 3.8pp to 76.7%. 

    Including the impact from the demand slowdown post-attacks and the price increases, we now expect volumes to remain pressured till mid 2H CY19E. With our 1Q estimates coming in line with actuals, and minimal changes to our overall estimates, we maintain our DCF based TP of LKR 1,360/share. Including a DPS of LKR 76.00 (DY of 5.6%), we expect a TSR of +10.3%. HOLD.

    Volumes under pressure till mid 2H CY19E

    In 1Q, gross revenues were down 3.6% YoY with domestic volumes down 14.9% YoY (-3.2% YoY in 4Q CY18 and +11.0% YoY in 1Q CY18). However, including value added taxes (VAT), levies paid to the government were down 5.6% YoY. As a result, net revenues were up 3.3% YoY. The volume decline came in after the excise duty hike in March 2019 which resulted in prices going up by ~LKR 5/stick (sticks over 60mm). As such, its most popular product John Player Gold Leaf (JPGL), is now LKR 60/stick. The switch to lower priced beedi and illegal cigarettes continues with Beedi now holding a 57.0% market share vs a 37.0% share for CTC. 

    On somewhat of a positive note, CTC noted that there is a switch to cheaper CTC products such as Navy Cut, while there was also a growth in premium brands. Post-April attacks, volume movement has been slow. While there were some production delays in the first few days, CTC managed to get back on track without any critical disruption. Including the impact from the demand slowdown post-attacks and the price increases, we now expect volumes to remain pressured till mid 2H CY19E. However, with CTC now paying lesser levies, we expect net revenues to be up 6.0% in CY19E.

    CTC continues to manage costs; we expect modest margin improvements

    CTC continues to source its leaf supply entirely from local growers and as a result, saw gross margins improve by 100bps for the quarter. With the impact on volumes due to regular price increases, and now due to the short-term impact since the attacks, management continues to focus on costs through efficient production and labour planning in order to offset the impact from lower volumes. As such, we continue to expect modest margin expansion over our forecast period. For CY19E, we expect operating margins to settle at 80.3% (+1.7pp YoY).

    We maintain our TP of LKR 1,360/share and HOLD rating

    The stock is down -8.0% YTD and up 24.0% YoY, and is currently trading at 14.2x our CY19E estimates. With our 1Q estimates coming in line with actuals and minimal changes to overall our estimates, we maintain our DCF based TP of LKR 1,360/share. Including a DPS of LKR 76.00 (div. yield of 5.6%), we expect a TSR of +10.3%. HOLD.