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Breathing in Change

The scent of smokeless smoke fills the air!

Quoting the last statement in our recent sales notes about HMSP, which said "It seems for Indonesians, exploring new flavors is more achievable than quitting smoking altogether!".

This rings true, as PT HM Sampoerna Tbk (HMSP) introduces TEREA Full Flavor, a fresh twist for Indonesian smokers with a delightful clove taste. Starting tomorrow, you can find it in all IQOS stores in Jakarta, but you'll need the advanced IQOS Iluma device to enjoy it.

As a heated tobacco product, IQOS heats real tobacco instead of burning it- an important difference between these products and cigarettes.

And because they don't burn the tobacco, these products are smoke-free, producing a nicotine-containing aerosol- which is addictive, but their science shows they are a better choice for adults than continuing to smoke cigarettes, producing on average 98% less carbon monoxide (CO) and 95% lower levels of harmful chemicals compared to cigarettes. The experience lasts about 6 mins or 14 puffs, similar to what you'd get from a regular cigarette.

With the introduction of this new variant, it undoubtedly has a very positive impact on the company.

As we all know, among the four categories of kretek cigarettes—SKM HT, SKM LT, SKT, and SPM—IQOS mostly penetrates the market through SPM, a category which typically caters to upper-middle-class smokers, as their cigarettes are not sold in 'ketengan' or in boxes of less than 20 sticks, which may not be every smoker's cup of tea.

With the new clove-flavored variant, we expect to attract the other three segments that already enjoy the taste of cloves. Especially with IQOS considering the introduction of more budget-friendly devices in the future, like the IQOS Bonds priced at Rp 250,000 in the Philippines, it is expected that many will shift to HTU products.

Actually, the shifting trend is already evident.

On an annual basis, Philip Morris International's total cigarette sales have been consistently declining. As of 2022, the sales stood at only 622 bn units, marking a significant 16% drop from 2018. In contrast, the sales volume of Heated Tobacco Units (HTU) has been steadily increasing.

On the flip side, PMI’s HTU sales reached a record high of 109 bn units, representing a 15% yoy growth from 2021, a massive 166% increment from 2018.

As Philip Morris has been aggressively transforming to smokeless products, it is not a surprise to see the growing sales of the company’s HTUs over the years.

If we want to compare, in Europe, the sales of HTU reached 12 bn sticks, covering an 8.6% market share. Meanwhile, in Japan, HTU sales amounted to 9.6 bn sticks, representing a 26.6% market share. However, in Indonesia, the market share of IQOS reaching only 3.1% in 3Q23.

This significant room for growth in the e-cigarette market can be further supported by a recent statement regarding tax increases which set at relatively lower rate compared to a 12% increase for conventional cigarettes.

In detail, the tariff increases for SKM I and II is set at 11.5%-11.75%. The CHT rate for SPM I and II categories sees an increase of 11%-12%. Meanwhile, SKP I, II, and III will experience a CHT tariff hike of 5%.

We also conducted a comparison of excise taxes between the categories, calculating the equivalent for IQOS per unit, like a cigarette. The outcome indicates that if IQOS is a traditional cigarette, the excise tax per IQOS unit is not as high as that of other products.

However, with the current minimal penetration of IQOS, other segments still play a crucial role as a significant revenue source for the company. That's why we anticipate a stronger earnings performance in 4Q23, projecting further margin improvement leading up to the 2024 election.

Our analyst, Niko, even projects HMSP to achieve a 14.6% CAGR in net profit over the next five years. This projection is based on the assumption of a 10.6% annual increase in blended ASP and a 7.0% annual decline in volume.

We maintain our BUY recommendation with a TP of Rp1,145, based on DCF, implying 14.2x and 8.5x forward PE and EV/EBITDA.

In conclusion, with the grand vision of IQOS: to replace every cigarette for adult smokers who want to continue smoking, well.. this might eventually happen - may be someday in the future. And later, all we know is that HMSP is everything behind it.

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