JTINTER ... Dec10

S & P Highlights
- The operating environment for the tobacco industry in Malaysia remains challenging with the government having introduced a series of measures aimed at curbing smoking activities, and a thriving illicit cigarette market.

- The recent higher-than-expected 3 sen per stick (+16%) increase in excise duty and the subsequent 70 sen per 20-stick pack increase in selling prices are expected to result in a contraction in industry volumes.

- In addition, with the widening gap between the prices of duty-paid and illicit cigarettes, competition from illicit trade is intense. Based on a study from the Confederation of Malaysian Tobacco Manufacturers,
illicit cigarettes accounted for 39.7% of the market during the March to May 2010 period.

- JTI has fared relatively well in a difficult environment with sales volume having risen by 6.6% YoY (based on distributor-to-trade data) in 9M10 vs. the industry’s 1.3% volume growth. JTI’s market share for
the nine-month period rose to 22.4% (+1.1 %-points YoY). JTI gained market share at the expense of British American Tobacco (Malaysia) (ROTH MK, MYR44.98, Not Ranked). JTI may have benefited from
some downtrading from premium to value brand cigarettes.

- JTI’s top selling brands are Winston, with a 13.2% market share in 9M10, followed by Mild Seven, with a 4.2% market share.


Recommendation & Investment Risks
- We re-initiate coverage on JTI with a Hold recommendation and a 12-month target price of MYR6.50. Although the operating environment is difficult, JTI has done well to gain market share. We expect its share
price to be supported by decent dividend yields of 4.9%.

- Our target price is based on dividend discount model (DDM) valuation. Key assumptions in our DDM model include 7%-8% cost of equity and 1% terminal growth.

-  Risks to our recommendation and target price include sharp hikes in tobacco taxes, greater competition from low-priced cigarettes and illicit cigarettes, and price wars.