Results

• Below: FY17 core net profit of RM501.9m came in below HLIB and consensus estimates, accounting for 88-90% of full year forecasts.

Dividends

• Final interim dividend of RM0.43/share brought FY17 dividend to RM1.69/share (FY16: RM2.78/share, which included a 46 sen special dividend from the disposal of fixed assets), representing a dividend payout of 98%.

Highlights

• Qoq: Overall volumes and premium segment market share declined 3.2% and 0.7% respectively, resulting in revenue decrease of 7.5% qoq. Subsequently, core net profit declined by 30% to RM103.4m.

• Yoy: Revenue declined 16.7% yoy as volumes declined 14.2% vs SPLY as the overall legal market shrunk at the expense of illicit (figure 4&5). Lower volumes and growth in non-premium segments and marketing expenses associated with introduction of Rothmans brand contributed to 34.2% decline in core net profit from RM157.4 to RM103.4.

• FY17: BAT volumes declined -16.6% yoy (industry: -8.8%) on the back of high incidence of illicit (58.3% share of market in 2017 vs 52.6% in 2016). Additionally, and strong competition in the lower price segment resulting in trading down from premium brand (Dunhill) to lower price options (figure 6). As a result of this, core profit declined 25.7% yoy to RM501.9m

• Market Share: BAT’s market share of the total legal market was 54.5% YTD (-5.1ppts vs FY16) mainly due to consumers switching to cheaper competitor options (BAT only launched their VFM brand Rothmans in October 2017). Premium brand Dunhill’s market share in 4Q17 was 37.8%, down from 42.2% in full year FY16. The launch of Rothmans in October 2017 should see the group reclaim market share. In December 2017, the group reported Rothmans accounted for 2.8% of the legal market.

• Prospects: Going forward, we expect the group to experience margin pressure due to consumers switching from premium brands to more cost friendly alternatives. We expect the growth of the Rothmans brand to reclaim market share lost by the group in 2017. Marketing expenses incurred in 4Q17 associated with the launch of Rothmans is expected to taper off going forward.

Risks

• Risks to BAT include a further unexpected excise revision fueling the acceleration of dwindling volumes, the continued spread of the illicit market, poor reception to the Rothman’s brand, weakening ringgit which would increase the group’s costs.

Forecasts

• Unchanged

Rating

• Whilst BAT faces challenges from i) margin squeeze as consumers down trade from Dunhill to Rothmans and ii) high incidence of illicit trade, we feel this has already been reflected in its share pruce which is now at a 18 year low. Maintain BUY as we see value at the current bottomed out levels with FY18-19 yield at 5-6%.

Valuation

• We maintain our TP of RM37.00 and BUY call (WACC: 8.2%; TG 3.0%).

Source: Hong Leong Investment Bank Research - 14 Feb 2018