We attended BAT’s FY21 results briefing and came away feeling neutral on its near-term prospects, given that the excise duties on e-cigarettes and vape products have been postponed indefinitely by the government. This is to make way for the tabling of a new law that will regulate vaping and e-cigarettes. This, in a way, is negative for BAT as it delays the launch of its vaping brand, Vuse, to the market. Not to mention that the potential generational ban on smoking would also be detrimental to BAT, considering that it would result in a gradual shrivelling of customer base. We maintain our HOLD rating on BAT, with an unchanged TP of RM12.14 (WACC: 9.5%, TG: 1.0%).

FY21 in a nutshell. BAT recorded volume growth for the first time since year 2002, driven by an illicit backflow. Legal domestic industry volume and BAT’s domestic volume both grew by 5% YoY as a result, while the illicit incidence fell by 6% YoY to 58%. This was made possible by the transhipment restriction introduced in Budget 2021 as well as the increased enforcement activities. Nevertheless, the black market continues to be a threat to the legal tobacco industry, as smugglers have increasingly diverted their operations from bigger ports to smaller coastal jetties. This has led to coastal smuggling accounting for 40% of volume currently, from 10% before the transhipment ban was implemented.

Potential generational smoking ban. In order to ban smoking permanently for the younger generation, MoH is exploring to impose a ban on the sale of smoking products to individuals born after the year of 2005. The Tobacco and Smoking Control Act is expected to be tabled in Parliament in March for this purpose, as well as to regulate the consumption of vape and e-cigarettes. That said, we opine that overregulation will likely fuel illicit cigarette sales as affected consumers will turn to the black market. Should a generational vaping ban be implemented, it would also be counterintuitive in nature, as vaping is a less harmful alternative available to the smokers. While this is not expected to be implemented in the short term, we think that the gradual shrinking of customer base would be detrimental to BAT over the longer term.

Stands ready to introduce Vuse. BAT has made investments to improve its vapour readiness in 4Q21, to ensure that the group stands ready to introduce Vuse to the market once vaping products are legalised. We highlight that it is still difficult to ascertain if the introduction of Vuse would be margin accretive or dilutive at this point, as it would very much depend on the regulated pricing on the product. However, given the initial marketing and promotional spend to encourage switching to Vuse, we are of the view that the new line of vaping products is unlikely to be a significant contributor to the bottom line.

Not expecting any impact to sales volume. Spike in Covid-19 cases has previously proven to have a negative impact on sales volume. However, management believes that the recent surge in cases is less likely to hamper sales, with Omicron being a much milder variant and there has yet to be any additional restrictions being imposed onto businesses or tightening of SOPs thus far. Besides that, government has also indicated that there will no more lockdowns going forward. Management is encouraged by the recovery in consumption following the reopening of economy and expects the recovery to continue.

Forecast. Unchanged.

Maintain HOLD. TP: RM12.14. We maintain our HOLD rating on BAT, with an unchanged TP of RM12.14 (WACC: 9.5%, TG: 1.0%), given that the indefinite delay on vape excise duty would also push back BAT’s own vaping products.

Source: Hong Leong Investment Bank Research - 17 Feb 2022