Investment Highlights

• We highlight the possibility of British American Tobacco (M) (BAT) being removed from the FBMKLCI Index as a component stock. We maintain our SELL recommendation and FV of RM36.70/share (WACC: 7.2% terminal growth: - 1.0%).

• How? There are two possible scenarios of BAT being removed from the FBMKLCI according to FTSE Bursa Malaysia Index Series ground rules. Refer Figure 4 of current ranking by market capitalisation.

1. Security is removed should its market cap ranking of eligible securities drop to ≤36th. As of 30th Oct market close, BAT’s market capitalisation ranking is 36th.

2. Security is inserted should its market cap ranking of eligible securities rises to ≥25th. As of 30th Oct market close, Press Metal Aluminium Holdings Berhad market capitalisation ranking is 24th.

• When? The market capitalisation ranking will be determined based on the last trading day of November, which is Thursday 30th Nov. Meanwhile, the effective replacement will take place on the trading day after the third Friday of December, which is Monday 18th Dec 2017.

• Sapura outperforms despite exclusion. The most recent change in FBMKLCI’s component stock dates back to 19th Dec 2016. Sapura Kencana Petroleum (now known as Sapura Energy) (Sapura) was replaced by IJM Berhad after its market cap ranking fell to 37th. Notably, the subsequent alteration did not have the expected impact. In fact, the opposite occurred with Sapura outperforming IJM on every basis we measured (Figure 2), namely, absolute return, relative return of FBMKLCI and relative return to sector benchmarks. That said, we believe performance tied to the inclusion and exclusion to FBMKLCI Index may have been heavily obfuscated by company specific factors.

• Ownership structure skewed towards foreign shareholding. BAT’s foreign shareholding stood at 87% as of late Sep 2017. With the exclusion of 50% held by BAT’s holding company, effective foreign shareholding appears rather elevated at 37% (vs 32% 3 years ago). We also think that FBMKLCI linked funds with tracking mandates may pose a risk as well. However, BAT with a decent dividend yield (4.0-4.8%) coupled with its preservation in the MSCI Emerging Market Index may prove supportive.
• Aside from the potential capital market impact to BAT, we think that perpetual regulatory hurdles and disruptive substitute tobacco products does not justify its lofty valuations (forward PE of 19.8x vs historical average of 17.7x).

Source: AmInvest Research - 31 Oct 2017