BAT’s 1Q18 core PAT of RM96.2m (QoQ: +16.8%, YoY: -20.0%) was below expectations due to unprecedented growth in the illicit market. Better volumes are expected going forward from “zerorisation” of GST and new government’s plan to curb illicit market. We reduce our FY18 PAT forecasts by 7.9% to account for larger VFM segment market share. However, we increase our FY19/20 forecasts by 1.2%/2.2% to reflect better industry volumes going forward from the expected cull in illicit. Maintain BUY call with unchanged TP of RM37.00 based on DCF valuation methodology (WACC: 8.2%; TG: 3.0%)

Below expectations. Reported 1Q18 core PAT of RM96.2m was below ours and consensus expectations, accounting for 17.4% and 18.2% of full year forecasts respectively, mainly due to the unexpected growth in the illicit market (Figure #2).

Dividend. 33 sen per share (1Q17:43 sen), going ex on 1 June 2018.

QoQ: Revenue declined 8.9% due to decline in overall industry volume and growth in VFM segment (priced at RM12) at the expense of aspirational segment (RM15.50). Despite this, core PAT grew to RM96.2m from RM82.4m (+16.8%) due to absence of RM21m provision for impairment of excise duties relating to unused tax stamps (in 4Q17) as well as lower marketing spend. Note that BAT incurred significant marketing cost with the launch of their VFM brand “Rothmans” in 4Q17.

YoY: Core PAT decreased by 20.0% from RM120.4m to RM96.2m in tandem with top line decline of 14.8% due illicit market claiming higher market share and unfavourable product mix as mentioned above.

Market share: BAT’s market share of the total legal market was 54.7% in 1Q18 (up from 53.9% in 4Q17 and 53.5% in 1Q18) mainly from growth from Rothmans, which was launched midway through 4Q17 as well as an unexpected growth from Dunhill.

Prospects: “Zerorisation” of GST from 1 June 2018 should see a spike in sales as BAT intend to pass on the savings to consumers, subject to government approval (note that tobacco players must seek approval before changing shelf prices). Additionally, BAT is optimistic that the newly elected government will increase efforts in curbing the illicit market. Pakatan Harapan’s (PH) alternative 2018 budget states the newly elected government intends to collect RM6.1bn in cigarette excise duty vs RM3.5bn estimated by the previous administration. We expect the new government to step up efforts to eliminate illicit cigarette trade, in turn boosting legal market volumes, and hence increasing excise duty tax collection in order to fill the loss of income from zerorising GST.

Forecast. We reduce our FY18 PAT forecasts by 7.9% to account for growth in the lower priced VFM segment at the expense of aspirational segment. However, we increase our FY19/20 forecasts by 1.2%/2.2% to reflect better industry volumes going forward from the expected cull in illicit.

Maintain BUY, TP: RM37.00. Post earnings revision, we maintain our TP of RM37.00 and BUY call (WACC: 8.2%; TG 3.0%).

Source: Hong Leong Investment Bank Research - 22 May 2018