- We maintain our HOLD rating on British American Tobacco (M) Bhd (BAT) with an unchanged DCF-derived fair value of RM68.60/share.

- BAT reported a 2QFY15 net profit of RM215mil to extend its 1HFY15 net profit to RM459mil. We deem the results, which are in line with our and consensus estimates, to be commendable given the industry’s present challenges, namely the 12% excise duty hike effective November 2014 and GST implementation in April 2015.

- A gross interim dividend of 78sen/share was also declared, leaving it on track to meet our FY15F estimate of 312 sen/share. Our gross DPS forecasts, which are based on a 100% payout ratio, translate to yields of ~5%.

- BAT’s revenue and earnings were lower both sequentially and on a YoY (for 1H) basis following the steep decline in its volumes (1HFY15: -9.5%) as well as higher trade spend. The revenue decline was smaller YoY in view of the price hike it undertook in 4QFY14.

- The fall in BAT’s 1HFY15 volumes, which is in tandem with the overall legal industry’s YoY decline of 9.6%, can be attributed to a particularly weak 2QFY15 (QoQ: -13%; YoY: -17.9%) given that volumes were only lower by 1.3% for BAT and 0.9% for the legal industry in 1QFY15. Key reasons cited for this is the volume correction post 1Q’s abnormally strong demand ahead of the GST rollout and subsequently weaker consumer sentiment in 2Q.

- BAT’s 1HFY15 operating expenses increased by 28% YoY. That said, we are not concerned given that it is due to the timing of its brand and trade marketing expenses. More importantly, we note that management’s decision to invest behind its brands during this softer period had paid off as its market share increased by 0.5ppt to 61.7%, led by its aspirational premium brand, Peter Stuyvesant.

- In line with its previous guidance, management said that contract manufacturing volumes are not expected to rebound in the near term. Exports have been on a downtrend and were lower by 14.5% YoY in 1HFY15 mainly due to decreased demand from Australia and South Korea.

- Looking ahead, we expect BAT’s earnings in the next quarters to be distorted by lower consumption levels during the June/July fasting month, as well as pre-Budget stocking and destocking activities. Nonetheless, we believe that BAT’s margins should improve in 2HFY15 in view of its lower trade spend and recent RM1.50/pack price hike, which management clarified should cover the bulk of GST costs.

- No change to our earnings estimates for now. Our fair value implies an FY15F PE of 22x. The stock is currently trading at a forward PE of 21x.

Source: AmeSecurities Research - 29 Jul 2015