3Q20 core PAT of RM66.9m (QoQ: +9.3%, YoY: -19.5%) brought 9M20 sum to RM116.2m (-26.2%). This is in line with ours and consensus expectations, at 76.1% and 74.1% of full year forecasts, respectively. Forecasts are unchanged. We upgrade our call from Sell to HOLD with an unchanged TP of RM9.00 based on a DCF valuation methodology (WACC: 9.5%, TG: 2.5%). Share price has retreated 25.2% since our Sell downgrade in May 2020.

In line. 3Q20 core PAT of RM66.9m (QoQ: +9.3%, YoY: -19.5%) brought 9M20 sum to RM116.2m (-26.2%). This is in line with ours and consensus expectations, at 76.1% and 74.1% of full year forecasts, respectively. Core PAT figure is arrived at after adding back RM14.0m from restructuring expenses for staff redundancies.

Dividend. Declared DPS of 21 sen goes ex on 12 Nov 2020, bringing 9M20 amount to 56 sen (3Q19: 29 sen, 9M19: 85 sen).

QoQ. Revenue rose 14.8%, mainly due to successful launch of VFM brand KYO and recovery in overall legal industry volumes (+6.6%) (see Figure #2). We note that legal volumes recovered QoQ due to reopening of certain sales channels post-MCO such as mamak stalls. Core PAT grew 9.3% in tandem with better sales.

YoY. Sales rose 7.4% due to higher volume sales (+12.2%). Despite this, core PAT declined -19.5% as the growth in volumes came from VFM brands Rothmans and KYO, which are lower margin products.

YTD. BAT’s sales (-10.3%) and volume (-9.0%) declines were due to contraction of the legal market attributable to illicit trade (see Figure #2-3), consumers down-trading to VFM brands (Rothmans and Kyo) and lesser duty free sales from MCO restrictions on travel. Despite lower operating expenses due to staff layoffs, core PAT declined (- 26.2%) by an even greater amount than sales mainly due to consumers down trading to VFM brands (which cost the same to produce but sell for a significantly cheaper price), which resulted in slimmer gross profit margin of 25.5% vs. 28.5% in SPLY.

Prospects. Despite QoQ uptick in overall legal industry volumes, we understand this is predominantly due to increase in VFM brand sales, which cost the same to produce but are sold at a significantly cheaper price (Rothmans: RM12.40/pack, KYO: RM11.50/pack) than premium brand Dunhill (RM17.40/pack). Going forward, we continue to expect consumers to continue to down-trade to VFM brands, which has grown from 14% of the total legal market to >28% currently. We reckon the Big-3 tobacco players are vying for market share in the VFM category, continuously launching newer brands at lower price points (see Figure #6). Note after BAT launched KYO (RM11.50/pack) at a price point which was 90 sen cheaper than their own VFM brand Rothmans in mid-2020, Phillip Morris responded by launching another new VFM brand ‘Bond Street’ at an even lower shelf price of just RM10.90/pack in October 2020.

Forecast. Unchanged.

Upgrade to HOLD. While we remain pessimistic on BAT’s earnings outlook from ongoing rampant illicit market activity and consumer down trading, we reckon BAT’s share price has bottomed out. Upgrade our call from Sell to a HOLD with an unchanged TP of RM9.00 based on a DCF valuation methodology (WACC: 9.5%, TG: 2.5%). Note that since our initial sell call in May 2020, BAT’s share price has declined 25.2%.

Source: Hong Leong Investment Bank Research - 30 Oct 2020