Philip Morris CR stock currently trades 11% above our target price. Since an extraordinary excise-tax increase on cigarettes is possible in 2003 following recent flood in the Czech Republic, the stock presently has more downside than upside. We therefore downgrade our long- and short-term recommendations from hold to reduce.
* Several representatives of the governing Social Democrats have recently indicated that the Cabinet might significantly raise excise taxes, including those on cigarettes, to cover flood-related expenditures. The scope of such a hike and the timing remain unknown. Retail cigarette prices, consumer demand, and consequently Philip Morris CR’s (PM CR) performance would be negatively influenced by increased taxation.
* Recall that the EU requires cigarette excise taxes in the CR to reach at least 57% of the retail price of the leading cigarette brand, and, at minimum, to an equivalent of EUR 1.28 per pack by 2007 (by the end of a three-year transition period toward tax harmonization). At present, the leading domestic brand is sold with an excise tax totaling approx. 40% of the retail price.
* We have assumed in our projections to date that the share of a cigarette excise tax on the retail price will increase by 340 bps in 2003 (to 43.4%) and that the per-pack price excluding VAT and excise tax (net price) will rise by the estimated rate of inflation in 2003, i.e., by 3% p.a. We estimate that an additional 1% of excise tax would lower PM CR’s expected 2003 sales and gross DPS by 0.9% and 1.6%, respectively.
* As an excise-tax increase on cigarettes is not specified in detail at the moment, we do not reflect the prospect in our valuation and leave our target price unchanged (CZK 10,510 per share based on discounted gross dividends). Nevertheless, as the stock price is already 11% above our target price and as the prospects of an extraordinary tax increase represent a downside for the stock, we downgrade our long- and short-term recommendations from hold to reduce.
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Jan Hajek