For Indonesia’s tobacco sector, we are beginning to see some light for next year. In the 2017 Draft State Budget (RAPBN), the government is budgeting only a 6 percent increase in tobacco excise revenue to Rp 149.9 trillion (US$11.5 billion) (figure 1) from this year’s forecast of a 15 percent excise hike for a target of Rp 142 trillion.

In our view, huge adjustments on average selling price this year following the 15 percent excise tax jump will result in slower-than-expected industry volume growth at minus 1 to minus 2 percent year-on-year (yoy) in 2016. Furthermore, revenue excise realization in the January-July period only accounted for 37 percent of 2016’s full year target.

Even if we include the two-month early excise revenue collection this year — a policy implemented at the end of 2015 — only 49 percent of the full year target will be reached, or about 6 percent lower than the January-July average of 2014 and 2015. Therefore, we believe the 2017 excise hike will amount to around 10 to 12 percent higher yoy instead of just 6 percent.

In terms of stick sales, the post-Lebaran festivities’ 2.4 percent month-on-month (mom) volume growth may still result in the government’s inability to meet the 2016 excise revenue target, unless the Directorate General of Customs and Excise decides to implement a similar move to book excise receipts two months in advance as was performed at end-2015.

Going into 2017, although the excise tax hike should be lower than in 2016, we believe the competition is still tough this year with British American Tobacco’s (BAT) aggressive moves to take up market share in Indonesia. Thus, we believe that HM Sampoerna (HMSP) and Gudang Garam (GGRM) should experience greater difficulties in passing on the higher excise tax ahead.

At this stage, we are still awaiting the final cigarette excise tax figure per stick to be announced in October 2016.

Despite increases in A Mild average selling price by 12 percent year-to-date (ytd), HMSP has maintained its market share of around 33 percent (figure 2), testimony to the company’s high brand equity.

This is despite BAT’s 5 percent discount on its Lucky Strike Mild products at the retail level in the form of extra packs (i.e. 100 packs to obtain five extra packs).

On a brighter note, HMSP’s focus on the premium full flavor machine-rolled cigarette (SKM FF) segment should help support margins through the launch of the one-of-a-kind Marlboro kretek (clove cigarette) called Marlboro Filter Black.

HMSP will produce the product and pay a brand royalty to Phillip Morris Indonesia (PMI), unlike the other Marlboro brands, where HMSP only generates 3 to 5 percent distribution margins.

At the stock level, we continue to like HMSP, and maintain our positive view with a higher target price of Rp 4,800 as we roll over our valuation to 2017, or 20 percent to Unilever Indonesia’s (UNVR) target price.

On GGRM, it has increased the price of its Surya ProMild by 3.7 percent to Rp 706 per stick, closing the gap with A Mild at Rp 1,108 per stick. This should help maintain margins. Other positive catalysts for GGRM are its mass-market exposure and undemanding valuation on 2017-forecast price-to-earnings (PE) ratio of 18.6 times, a 50 percent discount to HMSP, with a lower target price of Rp 72,300, based on a 2017-forecast PE of 21 times.

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The writer is an analyst at Bahana Securities.

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