Based on our ex-factory price survey data, there are signs of easing competition as many products launched within the period of 2015-2016 have seen aggressive price increases, narrowing their discount gap to the market leaders.

PT Bentoel International Investama (RMBA) has increased the Lucky Strike Mild 12-stick pack price by 21.1 percent year to date (ytd), while Djarum has increased those of LA Ice prices by 24.2 percent and LA Bold prices by 12.2 percent ytd.

Nevertheless, RMBA still provides a 6-week credit term to large distributors, compared to the industry standard of a cash payment 1-week credit term.

Although we expect a milder excise tax hike next year, which would be positive for the tobacco industry, we see potential risks stemming from advertising bans and the continued decline in industry sales volumes. Thus, we maintain our “neutral” view on the sector.

Under our coverage, we still prefer PT Gudang Garam (GGRM) over PT HM Sampoerna (HMSP) due to the following. First, a recovery in the purchasing power of the mid-low income segment is likely to benefit GGRM more as its products cater to the mass market. Second, the regional government election will potentially boost demand in the outer regions.

Third, a lower excise tax hike will likely benefit GGRM more due to a higher effective excise tax bracket. Fourth, GGRM is trading at a 2018 price to earnings
ratio (PER) of 17.6x versus HSMP’s 34.9x.

Our target price (TP) for GGRM is based on a 21x 2018 PER or a BUY with a 19 percent upside potential. Meanwhile our TP of Rp 4,200 (US$0.31) for HMSP is based on a 38x 2018 PER or a BUY as the minus 10.7 percent ytd market underperformance is attractive, in our view.

HMSP has increased its A Mild 12-stick pack price by 14.2 percent ytd, narrowing its discount to the larger A Mild 16-stick pack. The former product currently sold for Rp 1,129 per stick, at only a 2.8 percent discount to the latter at Rp 1,162 a stick.

That is much better than last year’s discount of 14.7 percent due to an aggressive pricing strategy launched by new entrants. RMBA’s Lucky Strike 16-stick pack, for example, was launched at discounts of 25 to 35 percent to A Mild products in May 2016.

HMSP recently introduced Magnum Mild, a revamp of Magnum Blue (tagged at Rp 1,110/stick), at a much lower price of Rp 725/stick. HMSP currently offers the low-tar low-nicotine machine-rolled cigarette (SKM LTLN) for three distinct target markets: A Mild for the premium market, U Mild for the middle market and Magnum Mild for the mid-low end market.

A similar strategy is implemented for full flavor machine-rolled cigarette (SKM FF) with DSS Magnum Filter 12 for the premium market, Marlboro Filter Black for the middle market and U Bold for the mid-low
end market.

In order to regain its lost market share, GGRM so far this year has not increased the selling prices of its leading product, Surya 16. As a result, Surya 16 is one of the best sales volume performers among the top 20 products surveyed by Nielsen up to August 2017 (excluding the outliers: LA Bold and U Bold due to a low-
base effect).

Historical trends suggest that GGRM’s price increases are usually implemented in the fourth quarter (4Q) of the year. GGRM’s ytd sales performance has been partly helped by the aggressive price increase of one of its head-to-head competitors, Apache, which narrowed its price discount to Surya 16 from 35 to
15 percent.

Djarum, meanwhile, has increased the selling prices for LA ICE by 24.2 percent ytd and LA Bold by 12.2 percent. On the other hand, its flagship products Djarum Super 12 and Djarum Super 16 saw milder price increases of 4.5 percent and 1.1 percent ytd respectively.

As the mild increases launched while GGRM maintained the average sales price (ASP) of its Surya 16, Djarum saw an 8 to 13 percent year on year (yoy) decline in the 8M17 sales volumes of its Djarum Super and Djarum Coklat. Nonetheless, the overall sales volume for the company declined by only 1.5 percent yoy in 8M17, mainly supported by other products.

RMBA seems to have started monetizing its market share this year with selling price increases similar to those of HMSP. However, this has negatively impacted the company’s sales volume performance which saw a 4.4 percent yoy decline as of August.

Similar to HMSP, the smaller packs of Dunhill Mild 16 saw a 9.6 percent price increase, while the larger packs of Dunhill Mild 20 did not see a price increase ytd. As for Lucky Strike Mild, the smaller packs saw an 18 percent ytd price increase, while the ASP of the 16 stick-pack increased by 9.6 percent.
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The writer is a research analyst at PT Bahana Sekuritas

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