- We reaffirm HOLD on British American Tobacco (M) (BAT) with a higher DCF-based fair value of RM69.50/share (from RM68.60/share) following its better-than-expected 9MFY15 results. BAT reported net profit of RM257mil for 3QFY15 to bring its cumulative 9M earnings to RM715mil.

- The group has also declared a third single-tier interim DPS of 78 sen, extending the total gross DPS announced thus far to 234 sen. Yields are decent, at ~5% for FY15F-FY17F.

- YoY, BAT’s 9MFY15 revenue was slightly lower by 1.9%. This is unsurprising given the continuous weakness in legal volumes. (Jan-Aug 2015: volumes -10% for total legal industry and BAT vs. 1HFY15’s -9.6% for industry and -9.5% for BAT). A key reason for the wider spread for YTD Aug is the fasting month, which occurred in 3Q this year.

- Given that BAT’s net profit was flattish YoY, we believe that the price increases it undertook in Nov 2014 (+12.5% to +14.3%) and Jun 2015 (+2.2% to +2.5%) have been more than able to offset the fall in sales volume. As it is, its EBIT margin was marginally higher at 27%.

- This ran contrary to our earlier expectation of a margin compression and was the main factor for the positive variance to our estimate (revenue was in line). Coupled with a cut in our opex estimate (bulk of which already registered in 9M), our EBIT margin assumption is tweaked upwards by 1-2ppts. This translates to a 5%-6.5% increase in our FY15FFY17F earnings estimates.

- Although last week’s budget reading made no mention of “sin taxes”, we caution that there still remains the possibility of an off-budget excise hike as seen last year (+3sen/stick or +12%). We understand that pre-budget stock loading activities this year had remained suppressed.

- Management had also affirmed our belief of downtrading activities from the premium segment to aspirational premium, ELPCs and potentially illicit sticks given the soft consumer sentiment. That said, they highlighted that BAT, which is premium-heavy, had still managed to achieve its highest ever market share (63.1% in Aug) as Dunhill held its ground while Peter Stuyvesant continued to surpass expectations.

- On the potential threat to cigarette volumes from ecigarettes, management said that its parent company is committed to the market but there are no plans for it to venture into the local vaping scene at present.

- 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. The stock is currently trading at an FY16F PE of 19x. Our fair value implies a forward PE of 21x.

Source: AmeSecurities Research - 28 Oct 2015