BAT has recently revamped and implemented its new route to market model, which is targeted to overcome the shortcomings of its predecessor, as well as reducing the cost to serve. BAT also believes that the proposed generational end-game could be counterproductive, indirectly driving more demand to the illicit market and ultimately failing to achieve the government’s goal in reducing tobacco harm. We make no change to our earnings forecast and also keep our DCF-derived TP unchanged at RM12.04 (WACC: 9.5%, TG: 1.0%). Maintain HOLD on BAT.

We recently attended BAT’s 1QFY22 results briefing and came away with the following key takeaways:

New route to market model. BAT has recently revamped and implemented its new route to market model, which will help to future-proof the organisation and overcome some of the shortcomings of its previous model. Under this new model, retailers will then be able to place order via multiple avenues including (i) online; (ii) reaching out to sales representatives; or (iii) calling the designated call centre. This is versus its previous approach that is more manual in nature, which involves their distributors going to the retail outlets physically to do prompt selling. Although this new model is not expected to boost sales volume, this new approach should help to reduce cost to serve by 20-25%.

No specific targeted mix. We note that more than half of the volume in the legal tobacco market is dominated by Premium brands, while Aspirational Premium (AP) and Value For Money (VFM) brands accounts for the remaining 16% and 32% respectively. For its own brands, Dunhill holds 60% of the market share in Premium segment, Peter Stuyvesant with 40% of the AP’s market share, and KYO and Rothsman with 35% of VFM’s market share. While focusing more on Premium brands would result in better margins, BAT remains cognisant of the market dynamics and will not limit itself to adhere to a certain target product mix. It stands ready to capture new opportunities that arises in any segment. With the ongoing high inflationary pressure environment, BAT is expecting to see more consumer downtrading going forward.

Duty free sales hampered. Prior to the pandemic, duty free sales accounted for c.5% of BAT’s revenue. Although borders have reopened and travelling has resumed, industry experts believe that the recovery of air travel volumes to pre-pandemic level is not likely to be immediate. Coupled with the change in regulations that will only allow outbound travellers to purchase duty free cigarettes, the contribution of duty-free sales to the group will undoubtedly be affected. Therefore, we think it is rather unlikely for duty free sales contribution to return to pre-Covid levels of c.5% anytime soon.

Regulations. With the Tobacco and Smoking Control Bill currently being finalised and expected to be tabled in Parliament in July, BAT reckons the full regulation will likely be implemented in 3Q22. Once it is implemented, BAT will then assess the impact of the regulation from the perspective of its go-to-market strategy. BAT also believes that the potential implementation of the generational end-game could be counterproductive and drive more demand to the illicit market, ultimately still failing to achieve the government’s goal of reducing tobacco harm.

Forecast. Unchanged.

Maintain HOLD. TP: RM12.04. We maintain our HOLD rating on BAT, with an unchanged DCF-derived TP of RM12.04 (WACC: 9.5%, TG: 1.0%).

Source: Hong Leong Investment Bank Research - 13 Jun 2022