Recently, the government made a strategic decision to halt any increase in cigarette excise taxes for 2025.
This decision comes after the National Financial Accountability Agency of the DPR proposed a 5% hike for next year.
However, the government’s main concern is the impact of higher excise taxes on consumer behavior, leading to the cancellation of the hike.
The situation stems from significant excise increases during the COVID-19 pandemic, with a CAGR of 14%.
If excise rates continue to rise, there’s a growing risk of "downtrading," where consumers switch to cheaper or even illegal cigarettes.
This situation could backfire on the government.
Instead of increasing tax revenue, we may see a drop in state earnings as more people turn to illegal cigarette products that don't pay excise duties.
As a result, the risk of losses to the state treasury rises, while the legal cigarette industry and public health also take a hit.
Imagine consumers opting for cigarettes priced at IDR 10,000 to IDR 15,000 per pack, even though the taste doesn’t compare to the premium brands they’re used to.
If excise taxes keep going up, the shift to illegal products becomes inevitable, undermining the effectiveness of fiscal policy.
Interestingly, in 2014 and 2019, when the government chose not to raise excise rates, state revenue from excise actually increased by 9% and 8%, respectively.
This shows that without a hike, the potential migration to illegal cigarettes can be curbed, keeping the market stable and excise revenues intact.
Thus, the decision to cancel the 2025 excise hike is expected to have a positive impact on Indonesia’s cigarette industry.
Why is this important?
Because only in the cigarette industry can companies pass on 80-90% of their COGS directly to consumers, with the largest portion of these costs being excise taxes.
Just think about how powerful cigarette companies are.
With 80-90% of their COGS tied to excise, cigarette company have unique leverage to maintain profit margins, even as excise rates fluctuate.
This resilience is why the cigarette sector stands out as one that can thrive, even amidst regulatory changes or rising operational costs.
And our favorite company in this space is HMSP.
HMSP holds a strong position in the industry with its flagship brand in the low-tar SKM segment, like A Mild.
Not to mention, their IQOS product has strong long-term growth potential.
For those unfamiliar, IQOS is a device that heats, rather than burns, cigarettes in HEETS sticks using HeatControl technology.
Consisting of a Holder, Charger, and HEETS, IQOS produces cigarette vapor without fire, smoke, or ash..
We believe now is the perfect time to see HMSP as an attractive investment opportunity.
Why?
Let’s take a trip back to 2017, when HMSP’s market cap hit IDR 500 tn with a PE ratio of 42x. At that time, the company enjoyed a premium valuation as investors were confident in its growth potential.
Market Cap HMSP
P/E Ratio HMSP
However, if we compare that to the present, despite HMSP's net income only dropping by around 60%, its market cap has plummeted from IDR 500 tn to just IDR 100 tn.
This means the drop in valuation has been far more significant than the decline in financial performance.
In other words, HMSP's current valuation looks highly undervalued, especially considering the company’s resilience in passing on most of the excise costs to consumers.
On top of that, with the cancellation of the excise hike in 2025, the potential for higher margins and stable performance becomes even more tangible.
If HMSP's valuation manages to recover, even partially to 2017 levels, investors could see substantial gains.
With this positive outlook, we recommend a BUY on HMSP, with a target price of IDR 1,565
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