We are initiating coverage on the cigarette sector with a Neutral recommendation mainly due to its resilient trait. Despite government’s campaign against smoking, Indonesia is the soil for tobacco/cigarettes (cigarette) producers. The main reason is that revenue originating from cigarette consumption has became a significant source of Indonesian government’s revenue. Indonesia is one among the few countries that has not signed the WHO’s Framework Convention on Tobacco Control (FCTC) agreement which implies that cigarette producers have more flexibility to produce, sell, and advertise their products in the domestic market compared to those which already have.
The indispensable multiplier effect
We think Indonesian cigarette producers have become indispensable. Our key argument is that cigarettes have become a significant source of the government’s tax revenue (contributing c.95% to total excise revenue). In addition, the complex dynamics between farmers and labor force.
Rising middle income households
Over the last ten years, Indonesian cigarette market has successfully adjusted to the changing demand of smokers from hand-rolled kretek cigarettes to the machine made kretek cigarettes. Furthermore, there is an increasing preference of adult smokers on low-tar and low-nicotine cigarettes. This implies that smokers’ preference has shifted from low products to mid-to-upper (premium) segments. Indonesia’s rising middle income households bode well with the on going cigarette consumption shift to premium products, in our opinion.
Smoking habit in Indonesia
Smoking dates back to the early 16th century when tobacco brought by the Portuguese were consumed by the then Indonesian kingdom, and later on by almost all level of society. Indonesia original cigarettes, known as kretek cigarettes, are made with a blend of tobacco, cloves and other flavors. Unexpectedly, in its history kretek cigarettes had been applied to effectively cure chest pains. Be it rumor or otherwise, the news spread and to have leveraged the habit of kretek smoking in Indonesia.
Relatively low selling price
As Indonesia is yet to ratify the FCTC agreement, Indonesian cigarette producers are not subject to the excise tax agreements within members that eventually regulate selling price. Compared to other countries, Indonesia sells cigarettes at a relatively cheap price. For example, the price of a pack of Marlboro cigarettes is USD1.35, compared to USD3.5 in Malaysia. Less regulated excise application permits lower costs and thus a more flexible selling price.
Initiate coverage with a Neutral recommendation
We are initiating coverage on the cigarette industry with a Neutral recommendation. We rate HM Sampoerna (HMSP) a Hold due to its stretched valuation and a Buy call on Gudang Garam (GGRM) for its steady fundamental improvement with solid establishment.