In the recently-issued Finance Minister Decree No. 146/2017, the government set an excise tax on cigarettes and a base cigarette retail price with a maximum 15 percent reduction of the government’s recommended retail price (HJE).

In addition, new brands launched should have equal or higher retail prices than existing brands offered by the same manufacturer.

Moreover, the government will also simplify the excise tax brackets from 10 tiers in 2018 to five brackets in 2021.

In our view, this is positive for the market leaders, namely HM Sampoerna (HMSP)’s low tar, low nicotine machine-rolled cigarette (SKM LTLN) and white cigarette (SPM) and Gudang Garam (GGRM)’s full flavor machine-rolled cigarette (SKM FF) with higher content of tar.

Consequently, smaller players that offer discounted pricing or pursue lower target markets will have to increase their average selling prices in order to compete with the two market leaders.

Therefore, we have raised our target prices for Sampoerna and Gudang Garam to Rp 4,500 (33.14 US cents) and Rp 83,000, respectively, based on unchanged targets for 2018 price-to-earnings of 38x and 21x, respectively, and raised our earnings forecasts on the back of better prospects for higher market shares. We also upgraded our outlook on Sampoerna to BUY (from: HOLD) and maintain our BUY recommendation on Gudang Garam.

We note that the excise tariff gap between the tier-1 machine-rolled cigarettes (Rp 590/cigarette) and the tier-2 machine-rolled cigarettes (Rp 385/cigarette) has widened from Rp 165/cigarette (in 2017) to Rp 205/cigarette (in 2018), up 24 percent year-on-year (yoy). This might be a disadvantage for producers of tier-1 machine-rolled cigarettes as smaller players face less excise cost pressure.

Similar to white cigarette producers, the excise tariff for the tier-1 cigarettes is set at Rp 625 (in 2018) versus Rp 370 and the tariff gap has risen from Rp 225 to Rp 255, up 13 percent yoy.

On the other hand, the tier-1 hand-rolled cigarettes (SKT) with retail prices higher than Rp 1,215, namely Dji Sam Soe Kretek 12, has seen a narrower excise-tax gap than lower-priced tier-1 cigarettes, namely Sampoerna A Hijau and Gudang Garam Merah.

A couple of key products surveyed, such as Lucky Strike Mild/Bold and Magnum Mild, have not complied with the new regulation.

Djarum has aggressively raised its average selling prices year-to-date (ytd) in accordance with the regulation, but at the expense of its sales volume (down 1.8 percent yoy).
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The writer is a research analyst at PT Bahana Sekuritas

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