JT International - Waning VFM market leadership but yields more attractive Hold

-  We maintain our HOLD recommendation on JT International (JTI), with an unchanged fair value of RM7.20/share, based on a 15% discount to our DCF value. 

-  Our cautious outlook on JTI’s brand equity strength is validated as it continues to underperform against the industry (volume retraced 1.3% vs. industry’s 1.7% gain). We expect JTI’s market share to grow 0.5 of a ppt in FY13F before rising to 22% in FY14F given the prolonged recovery of its flagship brand, Winston, and uncertainty in the sales volume of its premium segment going forward.

-  JTI’s principal brand, Winston (52.6% of sales), has yet to stage a significant volume recovery since its market share began declining in 1Q10 (-2.4ppts to 9M12’s 11.1%). Its 9M12 volume is down 6%, despite new line extensions having come onboard in April 2012. We believe JTI will continue to be hit hard by the proliferation of ELPCs, high level of illicit cigarettes (34.9%) and stiff competition within the legitimate industry.

-  We note that JTI’s product mix has been increasingly leaning towards the premium segment (26.1% of 9M12 sales volume vs. 9M11’s 22.4%) and Mild Seven is the only brand in JTI’s portfolio to register a positive growth this year (+15% YoY volume growth and +0.6 of a ppt market share). However, with its impending rebranding to Mevius, we are concerned that JTI may no longer be able to leverage on Mild Seven’s brand equity to grow its sales volume and hence, garner a higher market share.

-  The above also validates our belief that the premium cigarette segment (9M12 volumes +3ppts YoY) is weathering the challenging operating conditions better than the VFM segment (-0.6ppts) as a result of its less price sensitive customers and the rise in disposable income from the government’s various incentives. 

-  We anticipate overall legitimate industry volume growth to be muted (0% to +1%) in the next two years as the industry continues to battle stubbornly high levels of illicit cigarettes, a possible offbudget excise duty hike in 1H13, and increasing regulatory constraints (a new set of amendments is slated to take effect from 1Q13).

-  We do not expect any dividends to be announced in 4Q12 (9M12: 84 sen, including special of 24 sen gross) and have estimated gross DPS of 33 sen and 34 sen for FY13F and FY14F, based on a 65% payout ratio. We believe management will conserve its cash to finance its increased A&P activities, new machineries and launch of new products. At the current price level, its dividend yields of 4.9% to 5.1% are still attractive.

-  For those wanting exposure to the tobacco sector, we reiterate our Hold call on JTI for yield considerations. JTI’s valuation of 14x FY13F earnings is at an approximate 30% discount to BAT’s, while its yield of 4.9% to 5.1% is ~1ppt higher than that of BAT’s.  

Source: AmeSecourities