PP 7767/09/2010(025354)

26 May 2010

Malaysia Corporate Highlights

RHB Research
Institute Sdn Bhd
A member of the
RHB Banking Group
Company No: 233327 -M

Sector Upda te
26 May 2010
MARKET DATELINE

Recom : Neutral
Consumer Sector - Tobacco (Maintained)
Industry Changes From AFTA-Cept

Table 1 Consumer Valuations

Fair EPS EPS growth PER P/NTA P/CF GDY
FYE Price Value (sen) (%) (x) (x) (x) (%) Rec
(RM/s) (RM/s) FY10 FY11 FY10 FY11 FY10 FY11 FY10 FY10 FY10
KFCH Dec 8.50 9.63 77.1 89.5 17.2 16.2 11.0 9.5 2.0 7.0 3.1 OP
Amway Dec 7.45 8.45 54.5 56.5 23.6 3.5 13.7 13.2 5.0 7.4 6.7 OP
Carlsberg Dec 4.64 5.90 42.1 44.3 68.1 5.3 11.0 10.5 2.5 21.1 5.4 OP
Parkson Jun 5.12 6.40 29.2 36.3 15.0 24.3 17.5 14.1 2.7 6.9 1.4 OP
Faber Dec 2.10 3.40 26.5 24.2 16.4 -8.8 7.9 8.7 1.8 5.0 3.3 OP
QL Resouces Mar 3.65 4.60 31.1 36.5 15.4 17.4 11.7 10.0 2.5 8.1 2.8 OP
Daibochi Dec 2.71 4.20 35.1 38.0 16.9 8.3 7.7 7.1 2.9 6.5 8.3 OP
AEON Dec 4.99 5.80 41.4 45.2 8.7 9.4 12.1 11.0 1.6 11.0 2.4 OP
KPJ Health Dec 2.71 3.20 21.9 23.2 17.3 6.0 12.4 11.7 1.2 11.1 5.2 MP
Hai-O^ Apr 3.63 4.30 43.1 55.0 18.7 27.7 8.4 6.6 1.2 4.2 7.9 MP
BAT Dec 42.80 38.95 243.5 233.2 -6.9 -4.2 17.6 18.4 n.m 13.1 5.1 UP
Sector Avg 8.7 7.1 14.4 13.4
^ FY10-11 valuations refer to those of FY11-FY12

♦ No competition arising from AFTA-Cept yet. There have not been any new
Chart 1. TIV of cigarette
entrants into the Malaysian market yet as players believe that other regional
players are deterred from entering the market due to its floor price policy. bn sticks
25

Following the liberalisation, both BAT and JTI have hinted that they may
introduce new cigarette brands into the market to gain further market share.
20

♦
15

Some players have started / will be starting to import cheaper tobacco

leaves. Both BAT and JTI may import tobacco leaves from neighbouring 10

ASEAN countries soon as leaf cost from these countries is about 30-50% lower 5

than in Malaysia currently. We understand that Philip Morris (which 0

manufactures Malboro, Sampoerna and L&M) has already stopped sourcing for 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

local tobacco leaves.

♦ Phasing out production facilities in Malaysia? Both BAT and JTI will not be
phasing out their production facilities in Malaysia. However, their competitor,
Philip Morris has since closed its Ipoh plant in Malaysia, which is currently
manufacturing Sampoerna cigarettes. We believe there could also be a
possibility of Philip Morris completely pulling out its manufacturing activities
from Malaysia.

♦ Illicit market seems to have stabilised, but QoQ results expected to be

weaker from stock rotation. The level of illicit cigarettes seems to have
stabilised at the 37% level. However, both players hinted at a weaker 2QCY10
results arising from weaker QoQ sales volumes as inventory adjustments take
place (from the phasing off of the less than 20s stick pack) and as consumers
start to adjust to the shift to 20s pack as the ban takes place on 1 Jun 10.
However, no significant one-off write-offs is expected.

♦ Forecasts. No change to our earnings forecasts for BAT.

♦ Risks: More government campaigns to discourage smoking like the

implementation of pictorial warnings, or a potential ban on public smoking may
result in turning potential new smokers away.
Hoe Lee Leng
♦ Investment case. No changes to our DCF-based fair value for BAT at (603) 92802239
RM38.95 (based on WACC of 8.2%). Reiterate our Underperform call on BAT. hoe.lee.leng@rhb.com.my
We also maintain our Neutral recommendation on the consumer sector.

Please read important disclosures at the end of this report.

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Sector Update

♦ No competition arising from AFTA-Cept yet. YTD, we understand from local tobacco players that after the
implementation of AFTA-Cept in Jan 10, there have not been any new entrants into the Malaysian market
despite the lower cost of production (from lower labour costs and tobacco leaf cost) in their respective countries.
They believe that other regional players are deterred from entering the Malaysian market due to the floor price
policy (RM6.40/20s pack) implemented in Jan 10. The floor price reduces the benefit of entering the Malaysian
market as these low-cost producers generally compete on pricing rather than on branding (as with the cheap
whites). However, local tobacco players do not discount the possibility of new premium cigarette players from
trying to enter the market. Following the liberalisation, both BAT and JTI have hinted that they may introduce
new cigarette brands into the market to gain further market share.

♦ Some players have started / will be starting to import cheaper tobacco leaves. Both BAT and JTI may
import tobacco leaves from neighbouring ASEAN countries soon as leaf cost from these countries is about 30-
50% lower than in Malaysia currently. We understand that Philip Morris (which manufactures Malboro,
Sampoerna and L&M) has already stopped sourcing for local tobacco leaves. As for BAT, it will continue to
support local tobacco farmers and to satisfy the ASEAN content requirement of 40% for now. We estimate that
BAT would have to at least purchase 50% of its tobacco leaf requirements locally based on our simplistic
assumption that all the other cost components are local. While for JTI, we understand that it will also not be
importing all of its tobacco leaf requirements, as it too intends to continue to supporting the local tobacco
farmers. Furthermore, it would take some time for the tobacco players to find the right tobacco blend for each of
their brands (if new imported leaves were used), as changing the blend may change the taste of the cigarettes,
which could potentially cause a migration of its consumers to other brands.

♦ Phasing out production facilities in Malaysia? Both BAT and JTI indicated that they will not be phasing out
their production facilities in Malaysia. In the ASEAN region, BAT has manufacturing facilities in Malaysia,
Singapore, Indonesia, Vietnam and Cambodia while JTI only has manufacturing facilities in Malaysia. For Philip
Morris, it has manufacturing facilities in Malaysia, Indonesia and Philippines. We understand that Philip Morris
has closed its Ipoh plant in Malaysia, which is currently manufacturing Sampoerna cigarettes. This does not
come as a surprise to us as there have already been hints in the market that one of the major players in
Malaysia may be pulling out its manufacturing activities from Malaysia. We believe there could also be a
possibility of Philip Morris completely pulling out its manufacturing activities from Malaysia given: 1) its recent
acquisition of Fortune Tobacco Corp and further expansion of its warehouse facility in Philippines, which would
give Philip Morris additional production and storage capacity; 2) cost savings from higher utilisation capacity
from its plants in Philippines and Indonesia coupled with lower cost of production from cheaper labour and leaf
cost; and 3) Malaysia not being a core market for Philip Morris, given only c.13% market share as of CY09 (BAT:
c.65%; JTI: c.22%).

♦ Illicit market seems to have stabilised, but QoQ results expected to be weaker from stock rotation.
According to both players, the level of illicit cigarettes seems to have stabilised at the 37% level as local
enforcement agencies have been working harder in cracking down on illicit cigarette trade. Despite the
stabilising market share of illicit cigarettes, both players hinted at a weaker 2QCY10 results arising from weaker
QoQ sales volumes as inventory adjustments take place (from the phasing off of the less than 20s stick pack)
and as consumers start to adjust to the shift to 20s pack as the ban takes place on 1 Jun 10. However, both
players do not expect any significant one-off write-offs following the ban as both players have already taken
necessary precautionary measures to ensure any losses from this implementation will be minimised.

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Forecasts

♦ Forecasts. No change to our earnings forecasts.

Risk

♦ The key risks include more government campaigns to discourage smoking like the implementation of pictorial
warnings, or a potential ban on public smoking may result in turning potential new smokers away.

♦ Mitigating factors. These risks will inevitably affect the operation and profitability of tobacco players. To
mitigate the impact, these companies have continued striving to enhance its respective market share via product
innovation and marketing efforts to strengthen its market presence.

Valuation And Recommendation

♦ Maintain Neutral. Given the external pressures such as: 1) ban on packs less than 20 to be effective from 1
Jun 10; and 2) continued persistence by the Ministry of Health to reduce cigarette consumption, we believe
tobacco players may start to lose their defensive attributes, which have been giving investors consistent growth
and good dividend yield previously. As such, we maintain our DCF-based fair value for BAT at RM38.95 (based
on WACC of 8.2%). Reiterate our Underperform call on BAT. We also maintain our Neutral recommendation
on the consumer sector.

Chart 2: BAT Technical View Point

♦ BAT has been trading along the UTL since late
1990s.

♦ In recent years, as it moved higher along the UTL,

it penetrated a strong resistance level of RM40.20
in Nov 2008.

♦ Although there was an initial pullback to below

RM40.20, the stock regained its momentum and
headed to RM46.64, near the resistance of
RM46.30 in Aug 2009.

♦ Thereafter, the stock has been experiencing strong

profit-taking pressure.

♦ Yesterday, it closed the day at RM42.80.

♦ However, as it is still hovering at above the UTL

near RM40.20, its long-term uptrend remains firmly
intact, unless it loses this level.

♦ For the near- to medium-term outlook, it will still

likely trade within the upper resistance zone of
RM40.20 – RM46.30, in our view.

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IMPORTANT DISCLOSURES

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The recommendation framework for stocks and sectors are as follows : -

Stock Ratings

Outperform = The stock return is expected to exceed the FBM KLCI benchmark by greater than five percentage points over the next 6-12 months.

Trading Buy = Short-term positive development on the stock that could lead to a re-rating in the share price and translate into an absolute return of 15% or
more over a period of three months, but fundamentals are not strong enough to warrant an Outperform call. It is generally for investors who are willing to take
on higher risks.

Market Perform = The stock return is expected to be in line with the FBM KLCI benchmark (+/- five percentage points) over the next 6-12 months.

Underperform = The stock return is expected to underperform the FBM KLCI benchmark by more than five percentage points over the next 6-12 months.

Industry/Sector Ratings

Overweight = Industry expected to outperform the FBM KLCI benchmark, weighted by market capitalisation, over the next 6-12 months.

Neutral = Industry expected to perform in line with the FBM KLCI benchmark, weighted by market capitalisation, over the next 6-12 months.

Underweight = Industry expected to underperform the FBM KLCI benchmark, weighted by market capitalisation, over the next 6-12 months.

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