Results

• Below expectations: 1Q17 core net profit of RM120.4m came in below expectations, accounting for 16.2% and 16.4% of HLIB and consensus full year estimates.

Dividends

• Declared a first interim dividend of 40 sen/share (1Q16: 55 sen/share), representing a payout and yield of 96% and 0.85%.

Highlights

• Financial performance: Qoq domestic and duty free volumes declined by 11.6% largely driven by the continued expansion of illicit cigarettes in the domestic market, resulting in revenue declining by 8.3% qoq. Subsequently, core profit declined by 23.5% qoq. Yoy basis, revenue declined by 24.5%, whilst core net profit declined by 31.4% attributed to the same factors mentioned in the above.
• Illicit cigarettes constitute an estimated 57.1% share of market as at end-Dec 2016, an increase of 20.2ppts vs. end- Dec 2015 (36.9%). The top three illicit brands found in the market are John, Gudang Garam and Saat.
• In 1Q17, the group recorded a further RM1.6m one-off restructuring expense relating to the wind down of its factory operations.
• Volume: BAT’s and industry volumes contracted by 20.4% and 14.2% vs SPLY. The continued decline in domestic volumes can be attributed to affordability issues resulting from the 2015 excise revision and the rise of the illicit market.
• Market share: BAT’s market share of the total legal market YTD decreased by 3.6ppts to 53.5% vs end-FY16. This is attributable to the down trading environment and the group’s more premium skewed product mix. This is further evident in the Dunhill brand contracting to 37.3% share of market YTD from 42.2% share of market as at FY16 ( -4.9ppts). This evolution is partially offset by aspirational premium brands (Stuyvesant) gaining 1.2ppts share of market YTD from 6.5% in FY16.
• We continue to expect FY17 to remain challenging on the back of record high illicit market share, despite the tougher regulations and crackdowns. The economics and risk-reward tradeoff between consuming and trading in illicits on the back of the significant price gulf between illicits and duty paid cigarettes (RM5 vs. RM17) will continue to drive the demand and supply of illicits. Coupled with the solemn consumer sentiments and cost of living pressures, we continue to anticipate a further decrease in TIV in 2017.

Risks

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

Forecasts

• We revise our earnings forecast lower by 21%/18%/15% for FY17/18/19 as we adjust our volume parameters by 15% due to the continued downward trajectory of TIV.

Rating

• With persistent weaker volumes amidst higher cost of living and rising of market share for illicits at an all-time high of 57.1%, we downgrade our call to SELL.

Valuation

• We reduce our DCF derived TP to RM40.55 from RM48.23 (WACC: 8.2%; TG 3.0%) on the back of our earnings revision.

Source: Hong Leong Investment Bank Research - 21 Apr 2017