Jul 24, 2018 14:22:22

Dividend is the key driver
- If the cigarette stocks continue to be driven by relative dividend yields, GGRM should continue to outperform HMSP.
- 1H18 cigarette industry volume data suggest that HMSP’s volume declined 0.4% vs. GGRM's c.2% yoy volume growth during the period.
- Factoring in a 4% decline in HMSP’s 2018F earnings and GGRM’s higher 2019F capex (airport construction), we estimate GGRM’s yield at c.4% vs. HMSP’s 2.8%.
- Maintain sector Overweight. We now prefer GGRM over HMSP, though we maintain that HMSP is still the better long-term play on cigarette consumption trend.

Dividend yield as key to stock outperformance
In the past three years, GGRM’s share price has outperformed HMSP’s. Our analysis found the relative share price performances of the two stocks correlated strongly with dividend yields. GGRM started to outperform HMSP when its dividend yield rose sharply in 2016, resulting in higher returns vs. HMSP. The normalisation of GGRM’s capex and HMSP’s weak earnings momentum should allow the former to maintain a higher relative dividend yield, in our view.

Smokers continue to prefer high- and mid-tar cigarettes
According to Philip Morris International (PMI), the industry’s volume declined 1.5% yoy in 1H18, reflecting soft consumer purchasing power and higher-than-inflation excise tax hikes on cigarettes. Among the segments, high- and mid-tar cigarettes continued to support the industry’s growth, while hand-rolled and mild segments, and white cigarettes lost popularity.

GGRM consistently seizing market share
The consumers' smoking pattern plays into GGRM’s strength, as evidenced by its ability to expand its volume; much like what happened last year in 2017. Findings from our channel checks suggest that GGRM’s 1H18F volume grew c.2% yoy (vs. industry’s - 1.5%, according to PMI), despite c.8% yoy price increases. We project 1H18 sales growth of c.10% for GGRM vs. c.4% for HMSP. GGRM’s flagship, GG Surya, has been performing well (5M18 volume up 1.5% yoy, according to Nielsen).

HMSP remains a better long-term play
Indonesia smokers would likely shift back to the mild segment when purchasing power normalises; such is the trend globally. Economic uncertainties in the past few years and introduction of the mid-tar segment (effectively discounted cigarettes) led to market share shifting to ‘value’ cigarettes. Producers are incentivised to phase out such products eventually, in our view. HMSP’s firm position in the mild segment suffered, with its flagship A Mild hit (volume down 8% yoy in 1H18). Its 0.3% pt yoy market share gain in 1H18 to 33.2% was driven by low-margin products.

For now, GGRM is a superior stock
Assuming that value cigarettes stay trendy, GGRM should post relatively higher earnings CAGR of c.8% in 2017-20 vs. HMSP’s c.7%. We expect GGRM’s dividend yield in 2019F to remain superior to HMSP’s, unless its payout falls to less than c.43% (past three-year average: 72%). GGRM currently trades at 17x 2018F P/E, a discount of 52% vs. HMSP’s. Meanwhile, the government’s approval of e-cigarettes which have a 57% excise tax and could be sold from Jul 2018, has little impact on GGRM and HMSP, for now.