Global Automotive Stocks/EV Focus/Event Driven, SC Capital

SC Capital

Global Automotive Stocks/EV Focus/Event Driven

Over 22 years covering Japanese equities on both the sell side and the buy side. 

Bottom-up Japan Equities Research

Event-Driven

<ul><li>Since hitting its 52-week high on May 24th last year, Japan Tobacco (JT) has been one of the worst performing large-cap stocks in Japan (-14% versus the Topix index's rise of +17%) and the worst tobacco stock in the world.</li><li>This is largely due to rivals like Philip Morris (PM) and British American Tobacco (BATS) beating JT to the burgeoning "heat-not-burn" (HNB) cigarette market in Japan (where they can claim toxins in these products to be roughly 90% lower than regular cigarettes while charging higher prices), and this led to a loss of roughly 15% of JT's share of the domestic market.</li><li>This is a major setback for JT, as the domestic tobacco market represents close to 40% of global OP and, although JT is in the process of rolling out its own HNB product called "Ploom Tech", this loss of 15% domestic share is not something easy to win back considering how seldom smokers switch brands. </li><li>Because of this, JT's stock chart is bombed out and its FY18 EV/EBITDA multiple of only 9.1x is at a 34% discount to the average of 13.8x at global rivals (see Table-1 below). And this is why, with 11 Buys, 8 Holds and zero Sell ratings on the stock, all eyes are now on JT's February 7th results meeting, where the Street is waiting with bated breath for some (<em>any</em>) color on the progress of JT's Ploom Tech launch, after a 6-month delay.</li><li>JT has been totally tight-lipped regarding the profitability of its new Ploom Tech product, but the Street has high hopes, with estimates for a marginal profit ratio of over 50% from 2018 (the first year of product launch) and domestic OP margins rising from 36.5% in FY17 to 38.3% in FY18.</li><li>Having met JT every quarter for over a year now to check whether we can indeed trust these high-margin estimates on the Street, we were told sternly each time that JT has given <em>zero</em> guidance to the Street regarding profitability. JT said it may or may not have enough data to do so at its FY17 results meeting scheduled for February 7th. And this is why JT's results meeting next week will be one of the most highly awaited events this year in the Japanese equity market.  </li><li>We believe it would be totally reasonable for JT to guide for a year-on-year decline in FY18 domestic tobacco OP, as the HNB market is uncharted territory for JT and there are much more messy manufacturing procedures required than making normal cigarettes.</li><li>BAT recently commented at its Q3FY17 results meeting that its HNB product in Japan, "Glo", will most likely break-even by the end of this year, which implies that it takes over 2 years to generate profit on HNB cigarettes for BAT (further details are in this link: <a href="https://www.reuters.com/article/us-brit-am-tobacco-outlook/bat-targets-doubling-in-vapour-products-revenue-in-2018-idUSKBN1CU0JC" target="_blank">https://www.reuters.com/article/us-brit-am-tobacco-outlook/bat-targets-doubling-in-vapour-products-revenue-in-2018-idUSKBN1CU0JC</a>). But JT's true competition in Japan is PM and its iQos product, which has captured over 13% of Japan's tobacco market and has a 3-year headstart.  </li><li>While having lost so much share to PM from not having rolled out its own HNB product, JT does have some advantages relative to PM. For starters, JT doesn't need to spend the high amount of money PM did to educate the market on HNB cigarettes. Furthermore, JT has an enormous distribution channel in Japan, so if Ploom Tech is a hit, JT can deliver once mass-production is properly ramped up.  </li><li>But the question is how many Japanese smokers will fully switch to Ploom Tech from regular cigarettes. Initial studies show the rate at only around 20%. Taking share away from PM might be difficult after the foothold PM has gained. iQos is the closest to a real cigarette in terms of flavor and sensation, whereas Ploom Tech is closer to candy-coated vape products. There are many more pluses and minuses that bank on consumer preferences (e.g. cost and ease of use), but only time will tell.</li><li>JT has spent over Y84bn ($772m) over two years for investments in Ploom Tech. PM spent more than $2bn to launch iQos in 31 major cities around the world 3 years ago. This begs the question of where the world's most "addressable" market is for HNB cigarette products. According to JT, it's the US tobacco market. And unfortunately, here too, JT appears to be behind the curve.</li><li>PM has already gone through the multi-year, arduous process of filing with the Food &amp; Drug Administration (FDA), while JT has only just started recently. The FDA last week rejected PM's request to market iQos as a "reduced risk" product, but did agree to letting it claim lower levels of toxins. This means the US market may not be as sexy as Japan in terms of cultivation, but it is still the biggest potential market and PM is ahead. </li><li>So while JT's shares are indeed trading at a big discount to rivals (see Table-1 below), with consensus estimates showing JT's FY18 PER being 4.5% below average and EV/EBITDA at a whopping 34% discount to rivals, profitability and strategy may have something to do with this. Tobacco companies are, after all, looked at as "dividend minting" vehicles, so if JT's profits don't grow in the medium-term, a valuation premium may not yet be warranted.  </li></ul>

Since hitting its 52-week high on May 24th last year, Japan Tobacco (JT) has been one of the worst performing large-cap stocks in Japan (-14% versus the Topix index's rise of +17%) and the worst tobacco stock in the world.This is largely due to rivals like Philip Morris (PM) and British American Tobacco (BATS) beating JT to the burgeoning "heat-not-burn" (HNB) cigarette market in Japan (where they can claim toxins in these products to be roughly 90% lower than regular cigarettes while charging higher prices), and this led to a loss of roughly 15% of JT's share of the domestic market.This is a major setback for JT, as the domestic tobacco market represents close to 40% of global OP and, although JT is in the process of rolling out its own HNB product called "Ploom Tech", this loss of 15% domestic share is not something easy to win back considering how seldom smokers switch brands. Because of this, JT's stock chart is bombed out and its FY18 EV/EBITDA multiple of only 9.1x is at a 34% discount to the average of 13.8x at global rivals (see Table-1 below). And this is why, with 11 Buys, 8 Holds and zero Sell ratings on the stock, all eyes are now on JT's February 7th results meeting, where the Street is waiting with bated breath for some (any) color on the progress of JT's Ploom Tech launch, after a 6-month delay.JT has been totally tight-lipped regarding the profitability of its new Ploom Tech product, but the Street has high hopes, with estimates for a marginal profit ratio of over 50% from 2018 (the first year of product launch) and domestic OP margins rising from 36.5% in FY17 to 38.3% in FY18.Having met JT every quarter for over a year now to check whether we can indeed trust these high-margin estimates on the Street, we were told sternly each time that JT has given zero guidance to the Street regarding profitability. JT said it may or may not have enough data to do so at its FY17 results meeting scheduled for February 7th. And this is why JT's results meeting next week will be one of the most highly awaited events this year in the Japanese equity market.  We believe it would be totally reasonable for JT to guide for a year-on-year decline in FY18 domestic tobacco OP, as the HNB market is uncharted territory for JT and there are much more messy manufacturing procedures required than making normal cigarettes.BAT recently commented at its Q3FY17 results meeting that its HNB product in Japan, "Glo", will most likely break-even by the end of this year, which implies that it takes over 2 years to generate profit on HNB cigarettes for BAT (further details are in this link: https://www.reuters.com/article/us-brit-am-tobacco-outlook/bat-targets-doubling-in-vapour-products-revenue-in-2018-idUSKBN1CU0JC). But JT's true competition in Japan is PM and its iQos product, which has captured over 13% of Japan's tobacco market and has a 3-year headstart.  While having lost so much share to PM from not having rolled out its own HNB product, JT does have some advantages relative to PM. For starters, JT doesn't need to spend the high amount of money PM did to educate the market on HNB cigarettes. Furthermore, JT has an enormous distribution channel in Japan, so if Ploom Tech is a hit, JT can deliver once mass-production is properly ramped up.  But the question is how many Japanese smokers will fully switch to Ploom Tech from regular cigarettes. Initial studies show the rate at only around 20%. Taking share away from PM might be difficult after the foothold PM has gained. iQos is the closest to a real cigarette in terms of flavor and sensation, whereas Ploom Tech is closer to candy-coated vape products. There are many more pluses and minuses that bank on consumer preferences (e.g. cost and ease of use), but only time will tell.JT has spent over Y84bn ($772m) over two years for investments in Ploom Tech. PM spent more than $2bn to launch iQos in 31 major cities around the world 3 years ago. This begs the question of where the world's most "addressable" market is for HNB cigarette products. According to JT, it's the US tobacco market. And unfortunately, here too, JT appears to be behind the curve.PM has already gone through the multi-year, arduous process of filing with the Food &amp; Drug Administration (FDA), while JT has only just started recently. The FDA last week rejected PM's request to market iQos as a "reduced risk" product, but did agree to letting it claim lower levels of toxins. This means the US market may not be as sexy as Japan in terms of cultivation, but it is still the biggest potential market and PM is ahead. So while JT's shares are indeed trading at a big discount to rivals (see Table-1 below), with consensus estimates showing JT's FY18 PER being 4.5% below average and EV/EBITDA at a whopping 34% discount to rivals, profitability and strategy may have something to do with this. Tobacco companies are, after all, looked at as "dividend minting" vehicles, so if JT's profits don't grow in the medium-term, a valuation premium may not yet be warranted.  

Japan Tobacco (2914)--The Most Awaited 2018 Guidance in Japan

United States

Altria Group, Inc. is a holding company.  The Company, through subsidiaries, manufactures and sells cigarettes and other tobacco products, including cigars and pipe tobacco.  Altria holds an interest in a brewery company.

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Altria Group (MO US)

Japan Tobacco (2914)--The Most Awaited 2018 Guidance in Japan

Since hitting its 52-week high on May 24th last year, Japan Tobacco (JT) has been one of the worst performing large-cap stocks in Japan (-14%...

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