While we see glo as a viable product offering for Malaysian consumers, we understand that it will take a significant amount of time and marketing investment for it to have a significant impact on earnings. We keep our forecasts but with a lower DCF-derived TP of RM15.28 (from RM16.00) with higher WACC: 9.5% (previously 9.2%) and unchanged TG: 2.5%. However, we upgrade our call to HOLD given the decline in share price (-61%) since our downgrade.

What is glo? The glo (Figure #1) is a tobacco heating product (THP) recently launched by BAT in response to IQOS, which was launched by Phillip Morris International (PMI) in late-2018. As opposed to traditional cigarettes, THP works by heating up tobacco (instead of burning it), emitting dry vapour instead of actual smoke.

glo vs IQOS. Currently, the glo is available online (Lazada and Shopee), glo retail stores (Figure #3) and selected 7-Eleven, MyNews and Shell outlets around Klang Valley. Currently, glo is retailing for RM100, which is lower than the retail prices for PMI’s IQOS (Figure #4) of >RM169. BAT shared the significantly lower retail price represents “marketing investment” in the glo, which we reckon is necessary given (i) IQOS’s head start in the THP market; and (ii) high initial start-up cost for conventional smokers switching to THP. Note that in other major THP markets, the launch of glo lagged IQOS by 6-18 months (Figure #8 and #9) resulting the latter seizing first mover advantage. As it is still a relatively new product, THP currently only comprises c.1% of the overall smoking market (illicit/legal cigarettes take up the lion’s share at 25%/65%)

glo refill ‘neo’ represents better value to customers and BAT. glo refills, called neo are available in 4 flavours (Figure #2) and are currently available for purchase at selected 7-Eleven, MyNews and Shell outlets. Notably, shelf prices for neo of RM14.00 (including excise duty of RM4.00) are significantly lower than Dunhill shelf price of RM17.40 (including excise duty of RM8.00). This not only represents a cheaper price for consumers, but also better margins for BAT vs. traditional tobacco products. Note that neo refills are not a traditional cigarette and as such is not bound by the regular cigarette excise duty tax structure of RM8.00 per pack of 20s.

Outlook. While we see glo as a viable product offering for Malaysian consumers, we understand that it will take a significant amount of time and marketing investment for it to have a significant impact on earnings. Furthermore, given the relatively high cost of refills (RM14.00 vs <RM5.00 for illicit tobacco), we do not see glo eating into the chronic illicit tobacco market share, which has now risen to 65% of the total smoking market (Figure #5). Additionally, rising cost of living is fuelling the growth of VFM brand Rothman’s (RM12.40 shelf price) at the expense of premium brand Dunhill (RM17.40 shelf price) resulting in significant margin pressure. Since its launch in end-FY17, Rothmans has grown to 5.2% of the total legal market volumes (approximately 14% of BAT’s total volume). Plunging earnings has resulted in BAT announcing they intent to reduce 20% of their total head count, which should offer temporary reprieve for the group in facing unwavering negative macro factors.

Forecast. Unchanged.

Upgrade to HOLD, TP: RM15.28. Given the uncertainty of BAT’s future earnings, we take this opportunity to tweak our DCF valuation metrics from (WACC: 9.2%, TG: 2.5%) to (WACC: 9.5%, TG: 2.5%). Our TP falls from RM16.00 to RM15.28. Despite our lower TP, we upgrade our call from SELL to HOLD as BAT’s share price has declined 61% since our initial SELL call in Jan.

Source: Hong Leong Investment Bank Research - 20 Dec 2019