Results

• Below: 9M17 core net profit of RM419.5m came in below HLIB and consensus estimates, accounting for 71.1% and 67.3% of full year forecasts.

Dividends

• Declared a third interim dividend of RM0.43/share bringing YTD dividend to RM1.26/share (9MF17: RM1.55 /share), representing a payout and yield of 87.4% and 2.95%.

Highlights

• YTD: BAT volumes declined -15.3% yoy (industry: -10.1%) on the back of high incidence of illicit (56% share of market), and strong competition in the lower price segment resulting in down trading. Subsequently, core profit declined 19% yoy.
• Yoy: Revenue declined 18.8% yoy as volumes declined 12% vs SPLY. Gross margins improved 1.8ppts yoy on the back of the transition to sourcing from the new factory and trading model. Subsequently net profit declined to RM147.5m (-29.3% yoy)
• Qoq: Volumes declined 1.7%, resulting in revenue to decrease 2.2% qoq. Subsequently, net profit declined by 2.7% qoq.
• Market Share: BAT’s market share of the total legal market was 54% YTD (-3.1ppts vs FY16). On a qoq basis, market share declined by 0.6ppt qoq to 53.9% from 54.5% (attributed to growth in the low price segment). The Dunhill brand registered 38.4% share of market in 3Q (-0.6ppt qoq).
• BAT is playing catch-up in the low price range (PMI was first in market with the Chesterfield brand and a price point of RM12/20 stick pack) with the introduction of the Rothman brand which was launched in the first week of October. It is understood that the Chesterfield brand commands c.4.5% market share in this segment.
• We can expect opex to increase moving forward as BAT invests heavily into this new segment (opex +6.9% qoq) partially offsetting the optimization of its cost base transformation which has seen opex decrease by 17% YTD.
• New Illegal dynamics. Incidences whereby illicits now feature fake tax stamps have distorted the estimated illicit market share (56.1% at August 2017) as they’ve not been accounted for.
• Small packs. Management shared that the tobacco industry players are in talks with the government for the introduction of 10 stick packs in its effort to combat the incidence from illicit. We are neutral on this as we believe, that the driver of demand for illicit remain to be an affordability issue.

Risks

• Risks to BAT include a further unexpected excise revision fueling the acceleration of dwindling volumes, the continued spread of the illicit market.

Forecasts

• We cut our FY17-19 forecasts by 5% to take into account (i) lower volume assumption and (ii) higher opex assumptions in anticipation of higher investments into the Rothmans brand.

Rating

#bull# Despite showing signs of improvement, the share of market

• for illicits remains high at 56%, thus reinforcing our negative outlook for the sector. Maintain our HOLD call.

Valuation

• Our DCF derived TP decreases to RM38.43 from RM40.55 post earnings revision (WACC: 8.2%; TG 3.0%).

Source: Hong Leong Investment Bank Research - 30 Oct 2017