We attended BAT’s 2Q21 earnings briefing and came away feeling neutral on the group’s prospects going forward. Encouragingly, the government’s Budget 2021 initiatives to clamp down on illicit trade appeared to be paying off, with illicit reading declining from 64% (Dec-20) to 57.9% (May-21). Forecasts remain unchanged. While we expect 3Q21 profitability to be affected by the FMCO implementation (note that June volumes were greatly impacted), we are motivated by the promising clampdown on illicit activities. We maintain our HOLD call and DCF-derived TP of RM12.95 (WACC: 9.5%, TG: 2.5%).

We attended BAT’s 2Q21 earnings briefing and came away feeling neutral on the group’s prospects going forward.

Budget 2021 initiatives are paying off. BAT shared that Budget 2021 initiatives (transhipment restrictions, import restrictions, strengthening of multi-agency taskforce) are beginning to pay off. Note that since Dec-20, illicit reading has declined from 64.0% to 57.9% as of May-21. Despite this, BAT shared that illicit players are increasingly shifting their operations to import tobacco product via smaller jetties, making them more difficult to detect.

Vape legalisation a potential wildcard. BAT shared that it has been in constant communication with MoH with regards to the regulation of vape products that contain nicotine. While we do not expect vape to be legalised anytime in the near future, we believe that BAT is well positioned to quickly bring vape products to market given that it is already selling vape products in other markets. BAT estimates that legalising vape could result in as much as RM300m in tax collections per annum for the government.

Growth in VFM brands continue. VFM brands continue to be the strongest growing segment of the market, now accounting for ~30% of legal market volumes (vs. 28% in 1H20 and 21% in FY19). We believe the VFM segment will continue to grow at the expense of aspirational and premium brands given its lower shelf price (RM12.00/pack vs. premium brand Dunhill RM17.40/pack).

FMCO update. The latest FMCO rules will no doubt have an impact on BAT’s sales volume. Note that June legal volume halved MoM at the onset of the FMCO (Figure #3). However, BAT has shared that it is well prepared to deal with logistical hiccups, having ensured that its retailers are adequately supplied with sufficient inventory for the duration of FMCO, with the inventory increasing by 66.5% YoY in 2Q21. We believe BAT’s forward planning to hold larger amounts of inventory may be part of the reason its market share increased in 1H21 (BAT’s market share of the legal market increased by +1.5ppt to 52.4% vs. SPLY). While we anticipate BAT may be able to gain market share vs. their competitors in 3Q21 due to the availability of products in the market, we believe overall market volumes may be impacted by the FMCO.

Forecast. Unchanged.

Maintain HOLD. TP: RM12.95. While we expect 3Q21 profitability to be affected by the FMCO implementation (note that June volumes were greatly impacted, Figure #3), we are motivated by the promising clampdown on illicit activity. We maintain our HOLD call and DCF-derived TP of RM12.95 (WACC: 9.5%, TG: 2.5%).

Source: Hong Leong Investment Bank Research - 4 Aug 2021