We attended BAT’s FY20 full year earnings briefing and came away feeling neutral on the group’s prospects ahead. Going forward, we expect customers to continue to down-trade to VFM brands which estimated to account for 25- 30% of BAT’s sales volumes currently. As the meeting yielded no surprise, we keep our forecasts unchanged. We maintain our TP of RM11.75 based on unchanged DCF valuation methodology (WACC: 9.5%, TG: 2.5%) and HOLD call.

We attended BAT’s FY20 full year earnings briefing and came away feeling neutral on the group’s prospects going forward.

Rise of VFM cannibalising the industry. To recap, BAT shared that their total FY20 sales volumes shrank to 3.4bn sticks (-7.7% YoY) mainly due to continued high illicit reading, rise in vape popularity and loss of sales from duty free stores. Note that despite BAT’s overall lower volumes in FY20, VFM brands sales volumes (Rothmans and Kyo) grew by 174m sticks. We understand that growth of VFM brands are slowly cannibalising the industry. While VFM brands cost the same to produce, they are sold at lower prices (between RM12-13/pack of 20), resulting in slimmer margins. BAT shared that in particular, the aspirational market segment (e.g. Peter Stuyvesant RM15.90/pack of 20) is shrinking rapidly at under the threat of VFM products. We estimate that VFM volume now account for 20-30% of BAT’s volumes but only ~12-15% of revenue. Going forward, we expect customers to continue to down-trade to VFM brands at the expense of higher priced alternatives.

Legalisation of vape could prove to be a catalyst. According to a recent study done on the vaping industry in Malaysia, there is estimated to be over 1m consumers using vape products and over 3,000 SME retailers. By BAT’s estimates, approximately 11% of the total market in Malaysia currently consumes vape. We do not discount the possible legalisation of vape liquids that contain nicotine (which make up the bulk of vape liquid sales) as the study suggests tax collection on it could result in as much as RM300m in revenue per annum for the government.

Restructuring expenses. After incurring RM15.4m and RM18.8m in restructuring costs in FY19 and FY20, respectively mainly aimed at downsizing their workforce, we do not expect BAT to incur any further restructuring costs going forward.

Inflated balance sheet items due to Covid-19 precautions. BAT has taken steps to mitigate potential logistical issues arising from Covid-19. As BAT manufactures products in Indonesia and ships them to Malaysia, BAT has temporarily increased borrowings (RM510.0m in 4Q20 vs. RM421.0m in 4Q19) in order to finance higher inventory (RM229.9m in 4Q20 vs. 98.3m in 4Q19). This serves as a buffer should there be any logistical hiccups in the future.

Forecast. As the meeting yielded no surprise, we keep our forecasts unchanged.

Maintain HOLD. We maintain our TP of RM11.75 based on unchanged DCF valuation methodology (WACC: 9.5%, TG: 2.5%) and HOLD call.

Source: Hong Leong Investment Bank Research - 23 Feb 2021