Earnings Report /
Sri Lanka

Ceylon Tobacco: Q2 19 – Volumes to recover in late-H2; cost management helps margins

    Asia Securities
    15 August 2019
    Published by

    We maintain our target price of LKR1,360/share and maintain our Hold recommendation. Including a dividend yield of 5.7%, we derive a total return of +10.3%. Earnings were in line with our estimates with CTC reporting a Q2 CY 19 recurring net profit of cLKR4.7bn, up 7.5% yoy. Net revenues were down 1.0% yoy due to a 21.5% yoy domestic volume decline, driven by prices increases in March 2019 and an overall slowdown in consumer spending during the quarter post-April events. However, EBIT margins improved by 4.6ppts to 83.6% on the back of prudent cost management in a challenging quarter. On 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. While we expect volumes to pick up towards end-H2 CY 19, we remain cautious of the impact from cheaper alternatives and a possible price increase in November 19, ahead of the 2020 budget reading.

    Volumes to recover towards late H2 ; risk of price increase ahead

    In Q2, gross revenues were down 6.8% yoy with domestic volumes down 21.5% yoy (-16.0% yoy in Q1 CY 19 and +6.5% yoy in Q2 CY 18). However, including value added taxes (VAT), levies paid to the government were down 8.4% yoy. As a result, net revenues were down 1.0% yoy. The volume decline was driven by two price increases in the span of eight months (August 2018-March 2019) and the overall slowdown in consumer spending during the quarter post events in April. On 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. CTC noted that premium brands now account for 7.0% of the portfolio compared to 5.0% about a year ago. That said, growth in low priced products such as Capstan remain unchanged. CTC noted that volume growth has somewhat recovered from levels seen in Q2, and we believe volumes will begin to recover towards the latter part of H2 CY 19. We estimate net revenues to be up c3.0% yoy in CY 19e. Our key concerns remain 1) the threat from smuggled cigarettes and beedi, with beedi now holding a 57.0% market share vs a 37.0% share for CTC, and 2) another price increase in November ahead of the 2020 budget reading.

    Prudent cost management continues; we expect modest margin upside

    Cost of sales declined by 2.9ppts in Q2 as CTC adjusted production to cater to the low demand conditions. In addition, other operating expenses declined by 31.0%. These cost reductions offset the 50.0% yoy increase in employee benefit costs. As a result, EBIT margin improved by 4.6ppts to 83.6% during the quarter. With operations back to normal, we expect Q3 CY 19e EBIT margin improvement to come in at a more modest level. For CY 19e, we expect operating margins to settle at 81.4% (+2.7ppts yoy).

    We maintain our target price of LKR1,360/share and Hold rating

    The stock is down 8.1% ytd and up 5.7% yoy, and is currently trading at 13.9x our CY 19 estimates. With our Q2 estimates coming in line with actuals and minimal changes to overall our estimates, we maintain our target price of LKR1,360/share. Including a dividend of LKR 74.00 (div. yield of 5.7%), we expect a total return of +10.3%. Hold.