Investment Highlights

• British American Tobacco (M) (BAT)saw the successful launch of its Rothmans brand. While it could be dilutive on margins in the near term, we are convinced on its longer term value creation. We affirm our BUY call on BAT with a tweaked DCF-derived FV of RM36.00/share (WACC: 7.2% terminal growth: -1.0%).

• BAT’s 4QFY17 core earnings were RM102.9mil (QoQ: - 30.2%, YoY: -34.6%). This brought its full-year core earnings to RM522.4mil (YoY: -23%), in line with ours but below consensus at 98% and 92% of estimates respectively.

• A fourth interim dividend amounting to 43 sen/share was declared, bringing its total dividends to 169 sen/share for FY17 (FY16: 278 sen/share).

• Key takeaways from BAT’s results briefing were: i. Illicit cigarette market share rose to an all-time high of 59% after appearing to have displayed signs of improvement over the past 3 quarters. Despite the swing, we are assuming for operating conditions to gradually improve against a high base, contributing to our FY18 3% industry growth assumption (FY17: -3.0%). ii. Over FY17, BAT saw its market share slip to 53.9% from 57.1% in FY16 primarily due to its premium segment being chipped away. Going forward, we are assuming the launch of the value for money (VFM) Rothmans to regain at least 1% market share in FY18. Two months after its launch has seen a 2.8% market share gain. iii. Gross margins for the quarter deteriorated significantly to 31.0% from 36.5% (3Q17). This is largely due to the dilutive impact of its newly launched Rothmans and the related commercial spending. Despite the significant dilution for the quarter, management expects FY18 to reflect cumulative FY17 margins as its commercial spending on Rothmans normalises. iv. Exceptionals was largely due to the impairment of refund from the Royal Malaysian Customs (RMC) amounting to RM21mil. This is attributed to excess excise duties paid on tax stamps to the RMC, which is owned to BAT.

• Our forecasts are largely maintained, factoring in year-end housekeeping changes. Key risks to our forecast include a delay in an excise duty hike and greater-than-expected margin dilution related to its Rothmans brand.

• Valuations are trading at a multi-year low. It is currently trading at a forward P/E of 16.5x, well below its -2SD of 17.6x. At these levels, the reward to-risk appears attractive, especially when valuations eventually mean-revert. Apart from that, we like BAT’s more adaptable business model and capped downside risks.

Source: AmInvest Research - 14 Feb 2018