FY20 core PAT of RM260.7m is above ours and consensus expectations, at 108.4% and 108.2% of full year forecasts, respectively. The positive results surprise was due to better-than-expected legal market volumes. We raise our FY22/23 forecasts by 14.6%/22.4%. Maintain HOLD. After accounting for changes in forecasts, our TP rises from RM9.00 to RM11.75 based on DCF valuation methodology (WACC: 9.5%, TG: 2.5%).

Above expectations. 4Q20 core PAT of RM77.6m (QoQ: +16.0%, YoY: -31.4%) brought the full year FY20 sum to RM260.7m (-27.8% YoY). This is above ours and consensus expectations, at 108.4% and 108.2% of full year forecasts, respectively. The positive results surprise was due to better-than-expected legal market volumes. Core PAT figure is arrived at after adding back RM18.8m from restructuring expenses for staff redundancies.

Dividend. Declared DPS of 27 sen goes ex on 26 Feb 2021, bringing FY20 amount to 83 sen (4Q19: 33 sen, FY19: 118 sen).

QoQ. Illicit market share declined to 64%, which resulted in BAT volume and sales increasing by +3% and +5.2%, respectively. BAT attributed volume growth to strong performance in VFM (value-for-money) brands including Rothmans and KYO. Stronger sales translated into bottom line expansion of +16.0%. Overall, BAT’s position as the largest legal player held steady, at 52.4% (premium segment: 60.1%, VFM segment: 35.2%).

YoY. Despite flat sales (-0.3%), core PAT shrank by -31.4%. This was due to growth in the VFM brands (which have significantly lower shelf prices and hence slimmer margins) at the expense of premium segment.

YTD. Sales decline of 7.7% was due to -8% sales volume decline (-3% after excluding Covid-19 impact on duty free sales) as legal market contracted due to higher illicit activity, consumers down trading to VFM brands, and lack of duty-free sales as a result of Covid-19 impact on international travel. BAT shared that their overall market share of the smaller legal market pie was up by 1.1ppt to 51.7% vs. FY19. This was due to premium brand Dunhill and VFM brand KYO which grew 2.0ppt and 5.3ppt, respectively.

Outlook. Despite QoQ uptick in overall legal industry volumes, we understand that 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 and KYO: RM12.40/pack) than premium brand Dunhill (RM17.40/pack). We suspect the Big-3 are vying for market share in the VFM category by launching new brands at a lower price points and followed by subsequently raising the prices. Note that after BAT launched KYO at RM11.50/pack in Jul-20 and PMI launched Bond Street in Oct-20 at a lower price point of RM10.90/pack. Subsequently, the prices of KYO and Bond Street were raised to RM12.40 and RM12.00, respectively. Going forward, we continue to expect consumers continue to down-trade to VFM brands, which has grown from 14% of the total legal market in FY18 to an estimated ~30% in 4Q20.

Forecast. After factoring stronger growth in the VFM segment, we raise our FY2 21/232 forecasts by 14.6%/22.4%.

Maintain HOLD. After accounting for changes in forecasts, our TP rises from RM9.00 to RM11.75 based on DCF valuation methodology with unchanged WACC: 9.5% and TG: 2.5%.

Source: Hong Leong Investment Bank Research - 11 Feb 2021