Results

Above expectations – Reported 1HFY14 net profit of RM473.5m came above ours as well as consensus estimates. The group’s net profit accounted for 57.2% and 54.5% of ours and consensus’ full year earnings.

Deviations

Wider-than-expected margins.

Dividends

Declared second interim dividend of 78 sen/share, bringing. 1HFY14 total dividends to RM1.53, representing a payout and yield of 92.3and 2.6%, respectively.

Highlights

Financial performance: YTD revenue grew 5.7% yoy, despite lower volumes, largely attributable to the increase in cigarette prices. Selling prices differs by RM1.50 per 20-stick pack between both periods.

Bottomline recorded a healthier growth of 13.1% on the back of smaller growth in cost of sales vis-à-vis topline growth, which was partially offset by higher operating expenses (+18.8%) from higher investment and the impact of inflation on the group’s overall cost structure.

Briefing: The briefing was largely about the efforts made by enforcement agencies (Royal Malaysian Customs, RMC) as well as Ministry of Healty (MoH) on illicit cigarettes. RMC have launched Ops Outlet on 5 March 14, an intensive nationwide operation to curb the sales of illegal cigarettes.

We gathered that quite a number of retailers were raided, remanded and jailed. These raids have been reported on numerous media channels, which we believe would raise fears in retailers who sell illegal cigarettes.

Should these efforts proven effective, the Wave 1 of illicit cigarettes’ (due to be released soon) would report a decline in market share, from a peak of 38.9% in Wave 3 2013.

As for market shares by products in 1HFY14, Dunhill managed to maintain its leadership with 47.6% market share in the industry. Pall Mall and Peter Stuyvesant, on the other hand, recorded a market share of 4.6% (-0.7-ppts) and 3.9% (+0.8-ppts), respectively.

Separately, Dunhill have also launched a new line in early- July, known as Dunhill “Taste Flow Filter” which comes in Full Flavour and Menthol version. Packaging of the new product is shown in Figure 5.

Risks

(1) Exceptionally higher excise duty hike; (2) Increase in illicit trade volume; (3) Weaker-than-expected TIV; and (4) Regulation tightening.

Forecasts

Forecasts re upgraded to account for wider margins assumptions as BAT expects margins to be sustainable going forward. Hence, FY14-16 EPS is higher by 4.6-5.9%.

Rating

HOLD

Positives – (1) High dividend yield stocks; (2) Countercyclical share price pattern; (3) Oligopoly industry; and (4) Resilient earnings and low capex requirements.

Negatives – (1) Highly regulated industry; (2) Potential excise duty hike; (3) High level of illicit cigarettes in the market; and (4) Prices already reflect fundamentals

Valuation

Maintain HOLD with higher TP of RM68.54 (previously RM64.45) based on DCF valuations, post earnings revision.

Source: Hong Leong Investment Bank Research- 23 Jul 2014