Core PAT of RM361.1m (YoY: -22.9%) was above expectations, due to higher sales volumes and lower opex. We raise our FY20/21 earnings by 2.2%/2.4% to account for lower operating expenses going forward. After adjusting for higher earnings, our DCF based TP (WACC: 9.5%, TG: 2.5%) is increased from RM14.66 to RM15.00. Maintain BUY.

Above expectations. 4Q19 core PAT of RM113.1m (QoQ: +36.1%, YoY: +16.5%) brought the full year FY19 sum to RM361.1m (YoY: -22.9%). This made up 112.4% and 108.3% of ours and consensus full year earnings, respectively. The positive results surprise was due to higher-than-expected sales volumes and lower-than expected operating expenses. Core PAT figure was arrived at after removing RM15.4m in severance payments to staff laid off in 4Q19.

Dividend. Declared dividend of 33 sen (4Q19: 47 sen) per share (going ex on 17 Mar 2020) brought FY19 dividend to 118 sen (FY19: 155 sen) per share.

QoQ. Sales growth of 13.4% was led by growth in BAT’s sales volume of 14% (which was higher than the 8% growth in legal cigarette industry volume). This was due to seasonality, as 4Q is typically the strongest quarter due to festive season. Core PAT rose 36.1% due to (i) stronger sales (ii) lower operating cost due to cost rationalisation efforts.

YoY. Despite revenue decline of 14.0% from lower sales volume, core PAT rose by 16.5% from lower operating expenses as mentioned above.

YTD. BAT’s FY19 sales contracted -11.1% (in tandem with sales volume decline of 11.7%). Sales volume declined was due to rampant illicit tobacco market share of 63%, growth in illegal vape products (currently 9% of the total smoking market) and the emergence of heat-not-burn products (1% of the total smoking market). In addition to sales volume decline, growth of BAT’s VFM brand Rothman’s (at the expense of more pricey alternatives) resulted in lower sales as well as slimmer margins. Note that Rothmans has the same cost structure as all of BAT’s other cigarette brands but sells for a lower shelf price of RM12.40 (vs Dunhill: RM17.40). While cost reduction exercises resulted in 12.7% lower operating expenses, core PAT still declined 22.9%.

Prospects. We expect BAT to continue to reduce costs in light of decline in sales volume. BAT guided they intend to continue the process of reducing staff headcount in FY20. The entire headcount reduction is expected to result in annual cost savings of ~RM35m. Furthermore, we expect BAT to spend significantly less on A&P given the reduction in potential market size. Given the unreasonably high price of premium brand Dunhill, we expect consumers to continue to down trade to VFM brand Rothmans, which has grown from 3.2% of the total legal market at the start of FY18 to 6.7% currently.

Forecast. We raise our FY20/21 earnings by 2.2%/2.4% to account for lower operating expenses going forward.

Maintain BUY, TP: RM15.00. After adjusting for higher earnings, our DCF based TP (WACC: 9.5%, TG: 2.5%) is increased from RM14.66 to RM15.00. Despite the challenging marco outlook, we believe this glum has been more than reflected in its bashed valuations, at just 11.5x PE of FY20 earnings and projected dividend yield of 8.7%.

Source: Hong Leong Investment Bank Research - 21 Feb 2020