BAT’s 1H22 core PAT of RM131.9m (-2.7% YoY) was in line with our/consensus expectations, at 52.8%/51.5% of full year forecasts. Nevertheless, we expect consumer down-trading in the near term, which will result in a deteriorating margin. We lower our DCF terminal growth rate to 0% to reflect the government’s effort in curbing smoking habits via the soon to be implemented generational ban. TP is subsequently lowered to RM11.13 (WACC: 9.5%, TG: 0%), from RM12.14 previously. Reiterate HOLD on BAT.

Within expectation. BAT’s 2Q22 core PAT of RM75.9m (+35.6% QoQ, +6.0% YoY) brought 1H22’s sum to RM131.9m (-2.7% YoY). The results were within our and consensus expectation accounting for 52.8% and 51.6%, respectively. Core PAT was arrived after adjusting for Prosperity Tax which is estimated to be RM2.69m.

Dividend. Declared DPS of 25 sen (2Q21: 24 sen), which goes ex on 4 August 2022.

QoQ. 2Q22 sales volume increased by 20.7% to 0.9bn sticks thanks to the improving Covid-19 situation that has affected 1Q22 sales volume (i.e. Omicron wave). This is despite BAT’s market share sliding to 51.5% (1Q22: 51.9%) with its Value-for-Money (VFM) brands declining by 0.2ppt to 34.8%, Premium segment grew by 0.3ppt to 62.1% and Aspirational Premium (AP) brands held constant at 41.1%. In tandem with higher sales volume, BAT’s revenue was up 22.2% to RM637.5m, while core PAT advanced by 35.6%.

YoY. Top line registered a 7% growth thanks to higher sales volume (7% YoY) as consumer sentiment improved following the country's transition into the endemic phase with the reopening of international borders and easing of restrictions. Market share accretion was seen across the Premium and VFM brands, growing 0.9% and 0.7% respectively, whilst AP brands' market share declined by 3.4% as a result of delisting Pall Mall during the first half of 2022. All in, core PAT improved by 6.0%.

YTD. Revenue inched down 0.3% as a result of flattish sales volume growth, which was dragged by lacklustre 1Q22 sales volume due of the onset of the Omicron wave. As a result, core PAT softened by -2.7% for the same reasons mentioned above.

Outlook. Although cigarette sales volume is anticipated to recover steadily in 2H22 due to the reopening of the economy, BAT’s margin could deteriorate in the near term due to potential consumer down-trading during the current high inflationary pressure environment. Separately, the Tobacco and Smoking Control Bills was tabled to Parliament in July, and BAT expects it to be fully implemented by 3Q22. The implementation of the smoking bills will be a threat for BAT as the generational bans will result in a shrinking customer base over the long term. While vaporizers and e cigarettes will also be regulated under the smoking bills, allowing BAT to introduce its vape product, we opine the proposed ruling of RM1.20/ml excise duty on vape gels and liquids could fuel an illicit market, which could hamper BAT’s vape product penetrating into the market.

Forecast. Unchanged

Maintain HOLD, but with a lower TP of RM11.13. Taking cue from the government’s effort in curbing smoking habits, we revise down our terminal growth rate to 0% (from 1%). Consequently, our DCF-derived TP is lowered to RM11.13 (WACC: 9.5%; TG: 0.0%) from RM12.14. Despite BAT’s outlook being clouded by the sector's high regulatory risk, the current 11.7x FY23 P/E seems undemanding, trading near -1STD of its 5-year average of 15.2x coupled with an attractive DY of >8%.

Source: Hong Leong Investment Bank Research - 22 Jul 2022