• Results Inline: FY16 net profit of RM720m is slightly above our and consensus estimates. However after stripping the RM46.2m one-off restructuring income, core net profit of RM675m accounted for 105.0% and 99.3% of our and consensus full year estimates. We deem this to be in line with expectations.

• Dividends Declared a final interim dividend of 77 sen/share and a special dividend of 46sen/share bringing YTD dividends to RM2.78/share (FY15: RM3.12sen/share), representing a payout and yield of 110% and 5.7%.

• Highlights Volume: BAT’s and industry volumes contracted 29.7% and 25.7% YTD vs SPLY. The decline in domestic volumes can be attributed to affordability issues resulting from the 2015 excise revision and the rise of the illicit market.

• We anticipate a further marginal decrease in volumes in 2017 for BAT as contract manufacturing for exports had ceased as of 31 st Dec 2016. However, it is important to note that industry volumes have somewhat normalized at around 650m stick/ month in FY16 vs 925m sticks/month in FY15.

• YTD: The volume decline subsequently resulted in revenue declining by 18.0% yoy. Bottom-line contracted by 20.7% yoy (-25.8% yoy excluding EI).

• QoQ: Revenue declined by 9.8%, whilst core net profits declined by 24.5% due higher operating expenses (+10.5 qoq) due to timing. YTD gross margins shrunk 2.82ppts vs SPLY.

• Market Share: BAT’s market share of the total legal market in FY16 decreased by 3.8ppts to 54.3% vs FY2015. This is attributable to the down trading environment and the group’s more premium skewed product mix.

• Over the next 7 months BAT will transition to an asset-light importer-based tobacco entity with the bulk of the cigarettes to be imported mainly from neighboring Indonesia.

• We can expect FY17 to remain challenging on the back of record high illicit market share of 51.2% as at FY16 vs. 36.9% in FY15.

• Regulations pertaining to vapor products are still being developed whilst BAT will maintain its observer status pending further developments.

• Risks Risks to BAT include a further unexpected excise revision fueling the dwindling of volumes, continued spread of the illicit market and to a lesser extent growth of the parallel vaping industry.

• Forecasts We adjust our cost and opex assumptions for FY17 as we factor in lower the diminished volumes, the cessation of contract manufacturing and lower overheads. Consequently, FY17-18 EPS forecasts are raised by 5-7%.

Rating HOLD ↔

• Given volumes having shown signs of normalization, the transition to an asset light entity in progress and yields of 5.2% in FY17-18.

• Valuation Our DCF derived TP is raised to RM48.23 (WACC: 8.2%; TG 3.0%) from RM45.55 as we incorporate lower costs/opex assumptions and roll our valuations forward

Source: Hong Leong Investment Bank Research - 17 Feb 2017