- We reiterate our HOLD recommendation on British American Tobacco (M) (BAT) with a higher DCF-based fair value of RM70.60/share (from RM66.30/share earlier) following its better-than-expected 9MYF14 results.

- BAT registered a net profit of RM241mil (QoQ: -3%; YoY: +10%) in 3QFY14 to bring its 9MFY14 earnings to RM715mil (YoY: +13%). The results were ahead of our expectations, but in line with market’s.

- BAT had also declared a third single-tier interim dividend of 78 sen/share, extending the total gross DPS announced thus far to 231 sen (75% of our dividend estimates). Yields are decent, at 4.6%.

- While we had anticipated a sequential decline in 3Q volumes for both BAT and the total legal industry in tandem with lower consumption during the July fasting month and ongoing threat of illicit sticks, we were surprised to learn that legal TIV had expanded by 2% QoQ.

- Management believes this reflects the ongoing effort by the authorities to clamp down on the sale of illicit sticks through Ops Outlet and Ops Puntung. As it is, the illicit cigarettes’ share of market had shrunk by 3.1ppts, from 38.9% in Oct- Dec 2013 to 35.8% in Mar-May 2014.

- That said, we note that BAT’s volumes had bucked the trend, retracing by 1.9% QoQ following its unsuccessful attempt to be a price leader back in Sept. To be sure, BAT’s cumulative 9MFY14 volume growth now trails that of the industry’s by 0.4ppts (-7.4% vs. -7%) when at the interim, it had outpaced the industry’s by 0.7ppts (-6.9% vs. -7.6%).

- Management is nonetheless confident of a recovery in its volumes following the blip. Underpinning this are:- (1) the reversal of the price hike; (2) the encouraging reception of its new Dunhill (47.2% of legal domestic volumes) line extension – Dunhill Taste; and (3) the positioning of its aspirational premium labels (e.g. ‘reloc’ feature for Pall Mall) to ride on the rebound in legal volumes.

- The two price hikes in 2HFY13 – June 2013 (+3%) and Sept 2013 (+14% to +17%) – were more than able to offset the YoY volume declines and cost inflation for 9MFY14. Revenues were up by 5% while EBIT margin had expanded by 1.6ppts to 27%.

- In view of its strong 9MFY14 performance and our smaller FY14F-FY16F legal TIV contraction assumption of -6% to +1% (vs. -9% to 0%, previously), we have raised our FY14F-FY16F earnings estimates by ~6%.

- We believe BAT will continue to be of interest to investors despite the tobacco industry’s lack of positive catalysts, as the stock is a relatively safe consumer play offering stable returns in one of the market’s least cyclical businesses.

Source: AmeSecurities