Earnings Report /
Sri Lanka

Ceylon Tobacco: Lockdown results in further volume pressures; downgrade to Hold

  • Lockdown impacts Q2 CY 20e volumes; recovery will be slow

  • Prudent cost management to continue through CY 20e

  • We revise down our target price to LKR 900/share and our rating to Hold

Asia Securities
20 May 2020
Published byAsia Securities

With the impact on tobacco sales from the lockdown, we revise our target price to LKR 900/share (previously LKR 1,225/share). Including a dividend of LKR 71.00/share, we derive a total shareholder return of +5.5%. As a result, we revise our rating to a Hold from Buy. Earnings came in below our estimates for 1Q CY20 at LKR 3.9bn, down 3.2% YoY. Due to the impact of price increases in March 2019, and low sales due to the Covid-19 lockdown, which began mid-March, volumes declined by 13.0% YoY. However, net revenues remained flat YoY. The quarter saw interest income drop by 42.2% which resulted in the earnings decline. With the lockdown continuing till mid-May, we expect further impact on volumes in 2Q CY20E. Furthermore, due the impact on income levels, we believe consumption of legal products will see a slow recovery for the remainder of CY20E. However, we note that the company continues to be a strong dividend play.

Lockdown impacts 2Q CY20E volumes; recovery will be slow 

In 1Q, gross revenues were flat YoY, with the price increases in 2019 offsetting the volume decline of 13.0% YoY. Volumes were also impacted by loss of sales during the last two weeks of March due to the lockdown. We remind that despite the NBT removal and VAT reduction in December 19, CTC prices did not see any changes, as the government increased excise duties concurrently. With the lockdown continuing till mid-May, we expect further impact on volumes in 2Q CY20EAlso due to impact on income levels, we expect 1) low consumption of legal products and 2) consumers to switch to cheaper options such as Beedi, in the short-run. In addition, with the impact from price increases in 2019 wearing off in 1Q CY20, it will not be able to offset the volume decline. Hence, while orders from distributors are continuing to pick since the ban was lifted last week, we expect a slow recovery in volumes for the remainder of CY20E.  

Prudent cost management to continue through CY20E

Despite the volume decline, gross margins improved by 41bps YoY while EBIT margins improved by 73bps YoY. With the impact from the lockdown, CTC has taken several measures to manage costs and maintain profitability. We remind that CTC has taken similar measures in the past during occasions of exponential excise duty increases. With 2Q earnings pressured due to the lockdown, and also a reduced cash position due to increase in trade debtors, we believe CTC will continue these measures for the remainder of CY20E. We note that the import ban will have a minimal impact on CTC. Excluding base wrapping materials, all other components are produced in Sri Lanka. 

We revise our target price to LKR 900/share and our rating to Hold

The stock is down 16.4% YTD and down ~29.0% YoY, currently trading at 10.3x our CY20E estimates, a 25.7% discount to its 3-yr trading average. Given the higher than expected pressures on volumes, we revise our target price to LKR 900/share (previously LKR 1,225/share). Including a DPS of LKR 71.00, we derive a total return of +5.5%. As a result, we revise our rating to Hold from a BUY. We expect CTC to continue to maintain a payout of 75.0-80.0% and note that the company continues to be a strong dividend play.