Recommendations: Gudang Garam's (GGRM) Performance Still Pressured by Excise in 2024

ISSUER – JAKARTA, The implementation of the Tobacco Excise (CHT) continues to burden the business of level 1 cigarette manufacturers such as PT Gudang Garam Tbk (GGRM). Several efficiencies are being made to offset the erosion of sales volume.

Mirae Asset Securities analyst Rut Yesika Simak anticipates that 2024 will continue to pose challenges for cigarette issuers, especially for tier-1 manufacturers with a smaller contribution of Hand-Rolled Clove Cigarettes (SKT).

This is due to the increase in cigarette excise that is not commensurate with the Provincial Minimum Wage (UMP), which can perpetuate a downtrading situation, i.e., a shift to cheaper cigarette products.

In addition, the SKT segment and tier-2 manufacturers are still expected to benefit from a relatively smaller increase in excise. This is in line with the average excise tax increase of 10% for two consecutive years in 2023-2024.

“We are confident that the growing gap between the UMP increase and excise growth is a significant contributing factor. We believe that simplifying the excise structure will have a positive impact on major players like GGRM,” Rut Yesika revealed in her research dated January 4, 2024.

Rut believes that GGRM has been impacted by the excise policy structure, as evidenced by the increase in Gross Profit Margin (GPM).

As is known, the application of the excise rate for 2023-2024 of 10% is indeed slightly lower than the pandemic level of 12.5% in 2021 and 12.0% in 2022.

As a result, GGRM recorded a year-on-year margin increase but experienced a quarterly decline.

In the first nine months of 2023, GGRM's Gross Profit Margin (GPM) grew to 14.0%, Operating Profit Margin (OPM) to 7.3%, and Net Profit Margin (NPM) to 5.5%, compared to 8.2%, 2.1%, and 1.6% respectively in the same period in 2022.

Rut stated that this margin increase can be associated with a combination of several factors including a decrease in excise rates, Value Added Tax (VAT), and cigarette tax, which are influenced by a decrease in the sales volume of Machine-Made Clove Cigarettes (SKM) and a decrease in operational expenses (OPEX).

Mirae Asset anticipates that GGRM's EBITDA and net profit will continue to increase in 2024, driven by efficiency measures in various areas such as Advertising & Promotion (A&P) expenses and salaries.

However, the new excise tax regulations could hinder GGRM's revenue growth starting from the second quarter of 2024.

In the short term, GGRM will still benefit from the upcoming elections and is expected to achieve top-line growth in the first quarter of 2024.

The government has decided to implement a 10% increase in tobacco excise tax. cigarettes in 2023 and 2024. The amount of the excise increase will vary depending on the type of cigarette. In addition, there will be a 15% increase in electronic cigarette excise and a 6% increase in Other Tobacco Products (HPTL).

It is important to note that this tax increase mainly targets machine cigarettes (SKM), while hand-rolled cigarettes (SKT) are exempted because they are labor-intensive. For GGRM, the SKM segment is a top-line support with a contribution of about 90%.

Therefore, the sales volume of GGRM's SKM is expected to be lower. The sales volume assumption for the SKT segment is also projected to be low while maintaining profitability along with the improvements made by the company.

Rut added the potential increase in the inflation rate could also potentially push the government to raise interest rates to stabilize the rupiah exchange rate. Ultimately, this condition will impact GGRM's sales volume as people's purchasing power will decrease, especially for the SKM segment.

“Overall, the change in sales volume has lowered our revenue projection for GGRM in 2023 and 2024. However, going forward, we are still confident that the company can maintain an increase in profitability margin to offset the impact of declining sales volume,” added Ruth.

The sales volume of GGRM cigarettes lags behind industry growth. GGRM's sales volume fell by 25% YoY in the third quarter of 2023. Meanwhile, the cigarette industry's sales volume (for all cigarette categories) is still down about 5% YoY, reaching 219.1 million sticks during January – September 2023.

Rut recommends a Trading Buy for GGRM with a lower target price of IDR 24,500 per share, from previously IDR 30,000 per share.

This adjustment is due to lower-than-expected SKM segment cigarette sales in the third quarter of 2023, despite an improvement in margins.