PakistanTobaccoCompanyLimited

BettingonRisingConsumerism
ThursdayJune 27,2013

BUY
TargetPriceDec13:PKR217 CurrentPrice:PKR148
Bloomberg Reuters MCAP(USDmn) 12MADT(USDmn.) SharesOutstanding PAKT.PA PAKT.KA 386 0.02 255

InvestmentTheme
1) Increased market share and strong brand names enabling Pakistan Tobacco to pass on costimpactstotheconsumers 2) Young population (56% of population below 25) to ignite generic growth especially in lowandpremiumsegment(wherethecompanyenjoysthebiggestmarketshare), 3)Improvedoperatingmarginsduetotrimmedoperatingexpendituresandcostrationing 4) Curtailed financial charges amid better cash flows & stable inventory leading to retirementoftheentireloanportfolio 5) With historic payout ratio of 100% (last 5year average), the improvement in earnings duetoabovementionedreasonswillfurtherincreasepayoutstoshareholders
2012A 6.77 6.3 2013E 13.1 11.8 2014E 15.8 14.2 8% 47% 55%

Valuations
EPS DPS 2013DividendYield(%) CapitalGain(%) TotalGain(%)

Though the stock remains out of BMA Universe, we bring Pakistan Tobacco Company to investors radar as a firm investment opportunity having a potential to outperform the broadermarketandotherconsumersectorstocks.

Valuation:AstrongBuyofferingagrossreturnof55%
With an enticing expected earnings CAGR of 44% in 20132016, we initiate our coverage on Pakistan Tobacco Company Limited (PAKT) with a target price of PKR217, offering a capital gains of 47% and a dividend yield of 8% which is much more than that offered by any other multinational company. Our valuation technique is an average of three methodologiesi.e.historicalrelativepriceearningsmultiples,discountedcashflows(DCF) and dividend discount model adjusting for the premium associated to multinational companies. WithourearningsestimateofPKR13.1/shandPKR15.8/shfor2013and2014respectively, the stock currently trades at a price to earnings multiple (PER) of 11.7x and 9.7x. This implies that the company is currently trading at an undemanding discount of 75% (at 3 year average forward PE of 9.7x) when compared to multinational consumer companies and46%discountfromlocalFMCGcompaniesPEmultiples. At our conservative estimate of 90% payout ratio for 2013 and 2014 and going forward(5 year average of 109%), the multinational also provides a dividend yield of 8% and 9% in 2013and2014withdividendassumptionsofPKR11.8andPKR14.2persharerespectively.

PAKTvs.KSE100RelativeChart
KSE100Index 320 290 260 230 200 170 140 110 80 Jun12 Jul12 Aug12 Sep12 Oct12 Nov12 Dec12 Jan13 Mar13 Feb13 Apr13 May13 Jun13 PAKT

ShareholdingPattern
Others 2% Individuals 2% Institutions 1%

TobaccoSectorinPakistan
Pakistan is one of the bigger markets in Asia in terms of cigarette usage with annual consumption estimated at 88bn sticks. The market is dominated by two major multinationals;PakistanTobaccoCompany(BAT)havinganapprox.50%marketshareand Philip Morris Pakistan International having a market share of 32%. The remaining 18% of the market consists of small fragmented players (usually out of tax bracket sold in interiors)andhencetheirpricesareverymuchlowerthantheregulatedsegment. Both the big companies have expanded their capacities in Pakistan and hence have their own manufacturing facilities in the country enough to cater to the countrys current demand for cigarettes. Pakistan Tobacco Company operates with two manufacturing plants, one in Khyber Pakhtunkhwa and the other in Punjab having a combined annual capacityof~45bnsticks.
BMACapitalManagementLtd.801Unitower,I.I.ChundrigarRoad,Karachi,74000,PakistanForfurtherqueries,pleasecontact: bmaresearch@bmacapital.comorcallUAN:111262111 This memorandum is produced by BMA Capital Management Limited and is only for the use of their clients. While the information contained herein is from sources believed reliable, we do not represent that it is accurate or complete and should not be relied upon as such. Opinions expressedmayberevisedatanytime.Thismemorandumisforinformationonlyandisnotanoffertobuyorsell,orsolicitationofanyoffertobuy orsellthesecuritiesmentioned.11

British American Tobacco 95%

FurqanPunjani
Furqan.punjani@bmacapital.com +92111262111Ext:2064

Productportfolioandmarketshares
The demand for cigarettes is mainly confined to the low end segment where ~62% (55bn sticks) of the industry volume lies. The segment is largely dominated by Pakistan Tobacco Company having 57% of the market share with its well positioned valueformoney products: Capstan and Gold Flake (see picture on the right side). PMI competes with two well known brands in this segment i.e. Morven Gold and Red & White sharing 43% ofthetotalsegment.ThesellingpricesinthissegmentvaryfromPKR3538(USc3538)per 20cigerettepack.

LuxuryBrand:Dunhill

Apart from competing well in this segment, Pakistan Tobacco also has a 100% market share in the only premium brand available in Pakistan (this segment is one notch below the most expensive segment called Luxury) called Gold Leaf. This segment shares ~10% (8.8bnsticks)ofthetotalcigarettedemandinthecountry.Thepricesinthiscategoryvary fromPKR8085(USc8085)perpackof20. Another major segment which is positioned one notch over the lowest price segment shares hefty 28% in the industry volumes. Being a fragmented segment, Pakistan Tobacco has a share of only 12% which is 6% lower than its major competitor PMI, sharing 18%. The rest is shared amongst small local nontaxed companies and one listed company. The marginsinthissegmentareconsideredtobethelowestassellingpricesvaryfromPKR30 35(USc3035)perpack. The top most expensive category named Luxury by these two giants, shares only 0.5% of total volumes. Pakistan Tobacco Company (PTC) and PMI share an equal market (50% each).ThesellingpricesinthissegmentvaryfromPKR9095(USc7580)per20packs.

PremiumBrand:GoldLeaf

FinancialOverview
Being a highly competitive and consumer market the top two competitors fight for market shares primarily in low end and luxury segments. PTC has been the market leader since 2000, when price cuts in low end segment and better positioning enabled the company to beat the then best selling company, PMI. Pakistan Tobacco Companys gross volumeshavebeengrowingsince2008withlastthreeyearaveragegrowthof3%tostand atcurrentannualvolumetricsalesof40.6bnsticks.Thegrowthisprimarilyseeninthelow end division followed by the premium segment. Amid successive price increases to keep up with the rising prices of tobacco and maintain margins, the companys net sales have beengrowingatanexcessivepaceof10%inthelast5years.

ValueBrand:GoldFlake

The gross margins in last 5 years have varied from 27% to 41% with former being seen in 2011 as higher tax rate on sales was not passed on due to market competition, reducing the EBITDA margins to 6% compared to an average 25% recorded from 2007 till 2009. However, the same were passed on during 2012 where the companys gross profitability and EBITDA margins improved to 33% and 14% respectively. During the last 5year period when company underwent a decline in volumes (2010 by 11%), it managed to keep its doubledigitROEintactat71%in2009and11%in2011. In 2012 however, the industry scenario changed due to minimal increase in tax rates and better volumes (up 2%YoY) as the companies passed on the tax impact carried through out2011(perpackgrosssalespriceincreasedby10%).Resultantly,thenetsalesandgross revenues improved by 13% and 12% respectively. The gross margins due to above discussed factors increased to 35% or PKR8.4bn (USD84mn) compared to PKR6.2bn (USD62mn) in 2011. Moreover due to managements effort to trim the operating costs during last couple of years, the operating profit margins improved with an even higher
BMACapitalManagementLtd.801Unitower,I.I.ChundrigarRoad,Karachi,74000,PakistanForfurtherqueries,pleasecontact: bmaresearch@bmacapital.comorcallUAN:111262111 This memorandum is produced by BMA Capital Management Limited and is only for the use of their clients. While the information contained herein is from sources believed reliable, we do not represent that it is accurate or complete and should not be relied upon as such. Opinions expressedmayberevisedatanytime.Thismemorandumisforinformationonlyandisnotanoffertobuyorsell,orsolicitationofanyoffertobuy orsellthesecuritiesmentioned.22

ValueBrand:CapstanClassic


FinancialSummary
ProfitabilityRatios ROA ROE RoCE EPS PE DivYeild Payout BV/sh GrossMargin EBITDAMargin NetProfitMargin TurnoverRatios InventoryTurnover CreditorTurnover OperatingCycle AssetsTurnover FixedAssets CurrentRatio Quick/AcidTest DividendCover DebttoEquity InterestCover Govtlevies (%ofsales) (x) (x) Days (x) (x) (x) (x) (x) (x) (x) % 2.41 6.97 99 5.44 13.26 0.95 0.11 1.67 0.30 20.17 67.91 2.59 4.65 63 5.1 11.08 0.81 0.07 0.68 0.53 4.98 67.23 2.46 8.42 105 4.87 10.34 0.85 0.07 0.6 0.63 10.47 66.79 % % % Rs (x) % % Rs % % % 2012 12.75 42.08 32.65 6.77 9.99 6.00 59.88 16.08 32.63 4.65 6.68 2011 2.84 10.91 8.24 1.42 38.98 3.79 147.61 13.05 27.19 2.13 1.59 2010 7.52 25.68 19.52 3.62 30.44 5.44 165.71 14.1 29.61 3.78 4.42

pace by a hefty 9%YoY to stay at 11% during 2012 versus mere 3% in 2011. Thus the bottom line rose by 4.7x to PKR6.8/sh (USc6.7) compared to mere PKR1.4/sh (USc1.4) in 2011. During 1Q2013, companys net revenue and hence profitability increased by 28%YoY and 200% respectively due to hoarding on expectation of increase in government taxes in upcoming budget FY14. We expect this trend to continue in the current quarter (2Q2013) and would normalize from 3Q2013 onwards once pre bought cigarettes steal sales away fromthecompany.Howeverwithbettercashgenerationleadingtofallinbankborrowing (short term borrowing nil compared to PKR1.2bn in Dec12), the YoY profitability will remainupbeat.

AbouttheCompany
Pakistan Tobacco Company Limited, a subsidiary of British American Tobacco Company was incorporated in 1947 immediately after partition, when it took over the business of the Imperial Tobacco Company of India which had been operational in the subcontinent since 1905. The parent company, British American Tobacco has been in business for over 100yearsnowwithapresenceinover180countries.TheGrouphasbuiltaninternational reputation for making and marketing high quality brands for the millions of informed adults who choose to consume tobacco. The Company operates with two state of the art factoriesandemploysmorethan1,700people.Thecompanyismarketleaderwithalmost allthelegitimatebrandsavailableinPakistan.

ShareholdingPattern

The company is a closely held manufacturing concern with 95% of the ownership held by parent company, British American Tobacco (BAT). With only 5% of the free float available to common stock holders (12.75mn shares only), institutional holding accounts for 4% followedbyindividuals(1%).

BMACapitalManagementLtd.801Unitower,I.I.ChundrigarRoad,Karachi,74000,PakistanForfurtherqueries,pleasecontact: bmaresearch@bmacapital.comorcallUAN:111262111 This memorandum is produced by BMA Capital Management Limited and is only for the use of their clients. While the information contained herein is from sources believed reliable, we do not represent that it is accurate or complete and should not be relied upon as such. Opinions expressedmayberevisedatanytime.Thismemorandumisforinformationonlyandisnotanoffertobuyorsell,orsolicitationofanyoffertobuy orsellthesecuritiesmentioned.33