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Inhaling Change: E-Cigarettes

In the midst of the daily hustle and bustle, cigarettes have woven themselves into the fabric of society, transcending social and economic boundaries. From the bustling street corners of cities to the tranquil silences of rural areas, the sight of cigarette smoke curling into the air has become a commonplace scene. Unbounded by gender, with both men and women partaking, it's likely we all know someone within our circle of friends or family who smokes.

However, a particularly striking phrase has surfaced that may catch your ear - "Better to smoke than to eat." This controversial saying sheds light on a dilemma faced by some, especially in light of a shocking statistic from 2022. That year, an estimated 7.8 million smokers from among the poorest segments of Indonesian society chose to spend their money on cigarettes over nutritious food. This opener aims to explore the complex relationship between smoking and socioeconomic status, delving into the reasons behind such choices and the broader implications for society.

Despite the economic challenges marked by a 14% increase in rice prices in 2023, HMSP, a leading Indonesian cigarette company, defied trends with a 33% yoy surge in sales. However, a dip in revenue to IDR 1.9 tn in the last quarter, a 23% fall from its preceding period, reveals the complex dynamics of the tobacco market.

Source: Company, Sucor Research

The uptick in annual revenue for HMSP can be attributed to the robust performance of their SKT segment, which bolstered sales throughout 2023 even as their SKM segment saw a significant decline. This resilience was further enhanced by a premium pricing strategy, complemented by a 6.1% increase in ASP.

The subsequent drop in the previous quarter, however, was driven by a 10% decrease in sales volume, impacted by weaker purchasing power among consumers. Apparently, the increase in rice prices has begun to be felt.

Another significant hurdle impacting cigarette sales is the prevalence of illegal cigarettes, which are sold at much lower prices. Previously, these products were harder to come by, but they have now become readily available, even in small local shops.

An anecdotal example comes from a contractor renovating my house, who purchased a brand called Dubai. Priced between IDR 10,000 to 12,000 for a pack of 20, Dubai is just one among many illegal cigarette brands infiltrating the market.

HMSP, undeterred by the challenge of illegal cigarettes, pivots towards another unique offering in its arsenal - IQOS, targeting the mid to upper market segments. This product distinguishes itself by offering a smoking experience that feels closer to traditional cigarettes, compared to vaping, which many of my friends find lacks the authentic tobacco taste.

IQOS has gained acceptance in numerous countries without facing bans, unlike vaping products. An interesting reference point is the show "Exhuma," where one of the main characters is seen using IQOS, illustrating its cultural penetration and acceptance.

Vaping, on the other hand, faces stringent regulations and outright bans in several countries, such as Singapore. There, possession, use, and purchase of vaping products can result in fines up to IDR 23.5 mn, while importing, distributing, selling, or offering vaping products can lead to fines between IDR 117 mn to IDR 234 mn, or imprisonment for 6-12 months.

This smoke-free product is pulling its weight, contributing a hefty 36% to PMI's total revenue and setting its sights on snagging 10% of Indonesia's entire cigarette market in the mid to long term.

While its impact on HMSP's coffers is still on the lighter side, there's a strong belief in the air that IQOS is just warming up. It's expected to hit its stride, powered by growing adoption and the perk of lighter excise taxes compared to the traditional smokes.

So, zooming out to the big picture for 2023, the cash register rang up a cool IDR 8.1 tn in net income for HMSP, marking a snazzy 28% jump from the year before.

Source: Sucor Research

Looking ahead, our analysts forecast that HMSP is poised to chart a robust net revenue growth trajectory, pegged at an 8.7% CAGR over the next five years

Therefore, we're putting a BUY recommendation on the table, with a target price set at IDR 1,145.


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