Results

• Below expectations –1HFY16 net profit of RM223.4m came in below expectations, accounting for 29.5% and 28.6% of ours and consensus full year estimates. Adjusting for the one-off restructuring expense of RM85.7m, core profit was still below ours and consensus estimates (40.9% and 39.6%).

Dividends

• Declared second interim dividend of 45 sen/share bringing YTD dividends to RM1/share (1H15:RM1.56 sen/share), representing a payout and yield of 128.4% and 1.8%.

Highlights

• Volume: BAT’s domestic, duty free and contract manufacturing volume declined by 28.9% and 39% YTD vs SPLY. The decline in domestic volume was largely due to continued adverse impact of sharp excise duty hike back in November 2015.

• Financial performance: The volume decline subsequently resulted in revenues declining by 16.0% YTD. Bottom-line contracted by 51.3% yoy (-32.6% yoy excluding EI) despite the excise duty-led price hike of 23%-26% and cost saving initiatives.

• As for market share by products, BAT’s YTD market share decreased by 2.5ppts to 58.5% vs full year 2015.This is attributable to the down trading envi ronment post excise hike. Peter Stuy vesant’s continued to benefit in this environment with a market share growth of 0.8ppt or to 6.4% YTD.

• Management guided that the one-off expense of RM85.7m represented bulk of the restructuring costs. However as the restructuring is expected to only be completed in 1HFY17, should another round of provisions materializes, we can expect it to be to a lesser value as the main items such as provision for redundancies have been provided for.
• Dividends are down 36% yoy which is in tandem with the decline in profitability. Nonetheless, if we assume that the full net gain of RM148m on the property disposal and the M&E is sold at book value of RM192m, our pro forma calculation implies that a special dividend, of up to RM1.19 sen/share, yielding 2.6% could be in the cards.
• Should the government heed the call for a moratorium on ED hike, this would be no respite to BAT. We foresee that the share of illicit will continue to make ground due the large pricing gul f. Recall that illicits was at a record high of 45.6% in the month of December. BA T’s near term prospects are tied to the performance of the legal market , which at this juncture is at its darkest hour.

Risks

• Exceptionally higher excise duty hike;

• Increase in illicit trade volume;

• Weaker-than-expected TIV;

• Regulation tightening.

• Vaping Industry.

Forecasts

• We adjust our volume assumptions in light of the results. Our target FY16-17 EPS decreases by 16% and 1%.

Rating

• SELL

• 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) High regulatory risk; (3) High level of illicit cigarettes in the market;

Valuation

Downgrade to a SELL from a HOLD with TP of RM45.55 based on DCF (WACC: 8.23%; TG 3.0 %).

Source: Hong Leong Investment Bank Research - 27 Jul 2016