Pricing Strength, Weak Yen Lifting Japan Tobacco’s Profits

Wide-moat Japan Tobacco, or JT, beat its full-year profit guidance and our estimates, thanks to favorable currency movement. The results again reinforce our thesis that pricing will sustain JT’s profits and margins. To our surprise, management guides for flat adjusted operating profits (currency neutral) or a 6.4% decline in operating profits on a reporting basis for 2023 despite a high comp and exchange-rate uncertainty. We have raised our fair value estimate to JPY 3,200 from JPY 2,800 after adjusting our foreign-exchange assumptions and rolling the forecasts to 2023. While our new intrinsic value indicates 18% upside, currency movement, the Russia ruble in particular, will be a key swing factor to its near-term profits. Over the long run, the growth prospects of reduced risk products, or RRPs, especially in the lucrative home market and Russia, remain most critical to its profit and dividend outlooks.

Management has maintained the dividend at JPY 188 per share at a nearly 76% payout ratio of guided earnings per share. As we have cited, JT will continue to operate in Russia as long as the supply chain is manageable. We reckon eased competition in Russia is greatly in favor of JT, which helps lift margins and profits. Russia is expected to contribute 11% of the group’s sales and one quarter of the group’s profits in 2023, up from 22% of 2022, due to increased investment in RRPs in other markets and a decrease in one-off costs concerning supply disruption caused by Russia’s war in Ukraine in 2022. As a 1% change in yen/ruble rate moves the full-year operating profits by JPY 2 billion, massive devaluation in the ruble could lead to a dividend cut.