Comment

• Market Share: BAT’s market share of the total legal market was 54% ended 3Q17(-3.1ppts vs FY16). We expect BAT to gain market share with the launch of Rothmans.

• Launch of low cost option, Rothmans: The unaffordability of cigarettes in the legal market (~RM17.00 for premium brands) has seen consumers seek cheaper alternatives in low cost options or illicit cigarettes. As BAT did not offer a low cost option until October 2017, BAT’s market share declined from 57.1% in FY16 to 54% in 3Q17 of the total legal market. BAT will attempt to regain market share with the launch of Rothmans. Rothmans was launched in October 2017, priced at RM12/20 stick packs). PMI and JTI both already have low cost options with Chesterfield (RM12/20 stick packs) and LD (RM11.50/20 stick packs), respectively. While we are positive on Rothmans prospects going forward, we expect it to cannibalise BAT’s premium brands, which will result in narrower margins.

• Excise duty hike : We opine the likelihood of a hike in tobacco excise duty is low in the short term. Note that since excise hike by 40% in November 2015 (figure 2), illicit cigarettes ballooned to a high of 59.2% of total market share (figure 1). This has led to the government collecting significantly lesser taxes from tobacco products despite the higher excise duty. Raising excise duty again would further risk boosting illicit cigarette market and potentially reduce the government income from tobacco tax collection.

• Small packs . Management shared that the tobacco industry players are still in talks with the government for the introduction of 10 stick packs in its effort to combat the prevalence of illicit cigarettes. We are neutral on this as we believe that the driver of demand for illicit cigarettes remains affordability.

Risks

• Rampant growth in the illicit market, poor reception to the Rothmans brand.

Forecasts

• We reduce FY18-19 forecasts by 4.2%-5.5% to account for an increased number of consumers switching to VFM brands from premium cigarettes.

Rating

• We expect BAT to face short term margin squeeze from consumers down trading from premium brands to Rothmans. We do not expect illicit market share to continue to grow any further as it appears to have hit a ceiling (figure 1). Despite this, we reckon BAT is trading below its fair value. At current price levels, BAT dividend yields an attractive 6.2%

Valuation

• We reduce our TP from RM38.43 to RM37.00 post earnings adjustment (WACC: 8.2%; TG: 3.0%). However, we raise our call from a HOLD to a BUY after BAT’s share price has retreated sharply to RM31.82, hitting all time low since mid- 2000.

Source: Hong Leong Investment Bank Research - 8 Feb 2018