Highlights

• BAT announced that it intends to wind down its domestic manufacturing plant located at Virginia Park, Jalan University, Petaling Jaya. This disposal marks a signi ficant shift in strategy for the group’s operations in Malaysia.

• The company will restructure its business operations in Malaysia by procuring tobacco products for the domestic market from other BAT group factories in the region.

• This will result in the closure and the disposal of its manufacturing facilities held under BA T’s subsidiary Tobacco Importers and Manufacturers Sdn Bhd. The group expects to wind down its operations in stages and targets to completely wind down operations by 2nd half 2017. This is expected to reduce their head count by 230 or circa 23% as their workforce consists of around 1000 employees nationwide. Comments

• We are surprised by the marked shi ft in business strategy. The group cites that the high excise envi ronment has led to a sharp rise in illicit cigarettes, resulting in significantly lower sales volume. Volumes has contracted circa 24.16% since 2011 (2011: 8.75bn sticks vs 2015: 6.636bn sticks)

• Given the lack of disclosure on the announcement, we reserve our judgement on the matter pending further revelations by management. However, we believe that overall shift in strategy is positive for BAT as management is structurally changi ng the group’s cost structure due to limited topline growth on the back of decreasing industry volumes.

• On the disposal of manufacturing facilities, the previous disposal by BAT was back in 2010. Nestle paid RM36m for an industrial land in Mukim of Damansara, measuring approximately 40,602 sf. The proceeds were not paid out as a special dividend, but utilized as part of working capital in its entirety.

• Our channel checks indicates that a similar land disposal in the PJ precinct was DKSH selling two separate parcels of land for RM360.70 and RM480.0 psf respectively. Transactions in the area are priced between RM300-500 psf.

• Based on the 2014 annual report, the enti re operations complex in PJ (including the factory, office and store) has a size of 504,885.96 sf. The disposal would theoretically yield a potential disposal gain of circa RM94-195m or 33-68 sen per share assuming the complex is disposed in its entirety (the entire complex has a book value of RM57.48m and was last revalued in 1961).

Risks

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

Forecasts

• Unchanged pending further details on the disposal. Given the limited information it is hard to ascertain the expected cost saving and impact of changes in business strategy.

Rating

HOLD

• Posi tives – (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 TP of RM54.47.

Source: Hong Leong Investment Bank Research - 18 Mar 2016