We are neutral on BAT’s near-term prospects, despite vape products are likely to be legalised soon in Malaysia. BAT already has an existing portfolio of vape products standing ready to be launched as soon as the regulatory framework is established. However, we reckon that this new line of products will unlikely make meaningful contribution to its earnings in the near-term, given the heavy marketing and promotional costs BAT has to spend to attract vape users. We raise our earnings forecast for FY21-23f by c.9%, to account for the lower operating expenses that resulted from its cost optimization efforts. Maintain our HOLD call, with a higher DCF-derived TP of RM14.16 (WACC: 9.5%, TG: 2.5%).

3Q21 results summary. BAT’s 9M21 core net profit of RM213.4m (+26% YoY) came in above our projection at 83% of our full-year estimate. The outperformance was predominantly due to lower-than-expected operating expenses, as a result of the group’s cost optimisation efforts and lower restructuring costs.

Clampdowns continue to bear fruit. The stringent initiatives introduced in Budget 2021 have continued to work in favour of the legal tobacco industry, with the legal domestic industry volume growing by 6% YoY in 9M21. Management also noted that the illicit players have been increasingly moving their operations from big ports to smaller coastal jetties, making it tougher to detect. BAT has begun working with the authorities (i.e. multi-agency taskforce, marine police, law enforcement agents), to understand the modus operandi and provide intel on ways to tackle the illicit market.

Vape legalisation in sight. The government has recently introduced an excise duty to be levied on liquid or gel-based products containing nicotine in Budget 2022. This comes as a positive news as it levels the playing field for BAT and the legal tobacco industry, essentially allowing the legal tobacco players to introduce their own brand of vape products to the market. However, at this juncture, there is still a lack of clarity in relation to the regulatory framework, which is vital for the launch of the potential vape products. We understand that BAT stands ready to introduce vape products to the Malaysian market, given that it already has an existing portfolio of vape products that is selling in other markets. BAT also aspires to command market leadership in vape products within 3 years’ time. Management has previously estimated that the legalising of vape products could generate c.RM300m of tax collection a year for the government.

But do not expect immediate profits. While it is likely for BAT to introduce vape products to the Malaysian market in FY22 (once the regulatory framework has been established), we are not entirely optimistic for this new line of products to make significant contribution to the group’s bottom line instantly., We opine that it might have to undergo a gestation period, given the heavy marketing and promotional spend to attract vape users.

Forecast. We raise our earnings projections for FY21-23f by c.9% as we impute a lower operating expenses forecast.

Maintain HOLD. TP: RM14.16. Following our earnings forecast revision, our DCF derived TP is subsequently raised to RM14.16 (WACC: 9.5%, TG: 2.5%) from RM12.95. We maintain our HOLD rating on BAT, given the limited upside.

Source: Hong Leong Investment Bank Research - 9 Nov 2021