- We maintain our HOLD recommendation on British American Tobacco (M) (BAT) but raise our DCF-derived fair value to RM66.30/share (from RM62.00/share previously) as we roll forward our valuation year to FY15F.

- BAT’s 1HFY14 results came in within our and market expectations. Its interim net profit of RM473.5mil (+14% YoY) was commendable in light of the industry’s present challenges, namely the 14% hike in excise duty in Sept 2013 and stubbornly high illicit levels.

- A second single-tier interim dividend of 78sen/share was also declared. The higher payout (1QFY14: 75 sen/share) is a move away from its tradition of paying a similar quantum in 1Q, 2Q and 3Q before a higher final dividend in 4Q. We are keeping our gross DPS estimates unchanged as its payout ratio is unlikely to go beyond our current assumption of 100%.

- We note that BAT’s 1HFY14 YoY net profit growth was nearly triple that of its top line’s (5.7%). This can be mainly attributed to its higher operating margin (+1.8ppts), which more than compensated for the 6.9% YoY decline in sales volume. Its performance was better when compared to the total legal industry’s YoY volume contraction of 7.6%.

- That said, we are encouraged to learn that a recovery for legal volumes may be on the cards, thanks to greater enforcement by the authorities. After the steep 20% decline in legal volumes in 4QFY13 (the quarter immediately after the excise hike announcement), volumes have been on the rise in the past two quarters (1QFY14: +10%; 2QFY14: +5%).

- BAT’s YTD May 2014 market share was marginally lower, at 61.7%. This is not surprising given that BAT’s product mix favours the premium segment, which is currently impacted by downtrading activities (premium segment share of market: -0.4ppts; aspirational premium: +0.7ppts).

- Dunhill’s resilience, coupled with the group’s pole position in the premium segment (market share of 72.4%) had helped sustain its overall market share.

- On a slightly negative note, management said that contract manufacturing volumes (2/3 of volumes) is not expected to rebound in the future. YoY, 1H volumes were lower by 18% due to partial reallocation of orders from Japan to another facility, as well as lower demand from Philippines.

- Looking ahead, we expect earnings in the next few quarters to be distorted by lower consumption levels during the June/July fasting month, as well as pre-Budget stocking and destocking activities. No change to our earnings estimates at this juncture. Our fair value implies a PE of 22x its FY15F earnings.

Source: AmeSecurities