FY18 core PAT of RM468.5m was in line with ours but above consensus expectations, accounting for 100.4% and 105.6% respectively. BAT will face significant challenges in 2019 in light of IQOS’s launch in Malaysia. We expect BAT to respond in time with the launch of their own HNB device ‘Glo’ which should allow them to arrest market share losses to the IQOS. Despite this, the timing of Glo’s launch is uncertain for now. We keep our forecasts unchanged in the absence of earnings surprise. We maintain our SELL call and TP of RM24.50 based on a DCF valuation methodology (WACC: 8.4%, TG: 3.0%).

In line: FY18 core PAT of RM468.5m was in line with ours but above consensus expectations, accounting for 100.4% and 105.6% respectively.

Dividend. 47 sen per share going ex on 5 Mar 2019, bringing YTD dividend to 155 sen (4Q17: 43 sen, FY17: 169 sen).

QoQ: Top line was higher by 4.8% to RM770.6m due to increased shelf prices of 40 sen per pack and heightened buying activity linked to pricing uncertainty amongst customers following SST tax regime implementation. Despite total industry overall volume decline of 1.0% (evidenced by higher illicit market share in figure 2), BAT’s volume grew 2.2%. BAT explained this was due to their premium product offerings vs. competitors, as consumers of premium brands are typically more likely to stock up. Although topline performed better, core PAT declined 41.2% due to (1) increased cost of sales from SST implementation (2) absence of tax holiday (absence of GST resulted in better margins for BAT as shelf prices remained unchanged in 3Q18).

YoY: Core PAT declined 6.1% due to lower overall industry volumes and growth in the VFM segment (RM12.40 per pack) at the expense of Aspirational brands (RM15.90 per pack). Note that higher headline sales figure is predominantly due to GST removal.

YTD: Despite lower operational expenses from cost optimisation (-4.5%), core PAT declined 10.4% from unfavourable product mix due to growth in VFM brand Rothmans to approximately 4% of the total legal market currently (from under 2% in 4Q17). Additionally, lower profitability was due to 4.6% volume decline, partially due to rampant illicit market (figure 2).

Prospects. We expect the newly elected government to step up efforts to curb illicit trade to boost legal market volumes, in turn, resulting in higher excise duty tax collections. Despite this, we are reticent to factor in significant decrease of illicit market share as this endeavour has execution hurdles and will take time to bear fruit. Furthermore, BAT will face significant challenges in 2019 in light of IQOS’s launch in Malaysia. We expect BAT to respond in time with the launch of their own HNB device ‘Glo’ (already available in select other markets, figure 3-5) which should allow them to arrest market share losses to the IQOS. Despite this, the timing of Glo’s launch is uncertain for now. Note that the launch of Glo lagged IQOS’s launch in Japan and S. Korea by 18 months and 6 months, respectively (figure 4&5).

Forecast. Unchanged.

Maintain SELL, TP: RM24.50. We maintain our SELL call and TP of RM24.50 based on a DCF valuation methodology (WACC: 8.4%, TG: 3.0%).

Source: Hong Leong Investment Bank Research - 22 Feb 2019