BAT is cautiously optimistic about its prospects on the back of recovering cigarette sales with Malaysia in the endemic phase. While the “generational endgame” is now revised to apply to people born after 2007, BAT still believes such a ban will be counterproductive and ultimately fuel the illicit market. Also, the high inflation environment has put BAT’s margin under pressure owing to higher input costs and consumer down-trading activities. We maintain HOLD with a TP of RM11.13 (WACC: 9.5%, TG: 0%).

Yesterday, BAT Held Its 2Q22 Earnings Briefing With the Following Key Takeaways:

Brand building strategy. In 2Q22, BAT’s market share eased to 51.5% from 51.9% QoQ due to a drop in market share in the Aspirational premium segment (AP: -3.4ppt QoQ) despite growing Premium and VFM segment’s market share. The fall in AP market share was mainly due to the delisting of Pall Mall during 1H22 as part of the group’s brand-building initiative. Going forward, the group will continue to monitor its current brands’ performance and retain those that have healthy brand equity, such as Peter Stuyvesant (c.6% of total market share or 40% of AP’s market share). While the delisting of Pall Mall will lead to a lost in market share and some down-trading activities in the near term, the group believes such a measure will free up the resources to focus on growing its well-performing brands.

The Generational Ban. Although the “generational endgame” is now being revised to apply to people who were born after 2007 (from 2005), the group flags that there is a lack of scientific evidence of the effectiveness of such a ban. BAT also believes it is a prohibitive way to reduce the health impact of smoking, and it will only fuel the illicit tobacco market, which currently stands at 57.7% of the TIV in 2Q22. Ultimately, BAT thinks that the winner of the generational endgame will be the smugglers while the loser will be the government and affected consumer. This is because the former will experience lower excise duty income while the latter will be forced to buy illicit cigarettes or vape, which poses health and safety risks. Nevertheless, we note that the earnings impact of the implementation of the generational endgame will be mild in the early stage and probably take years to be reflected as (i) people who were born in 2007 will only become 18 year old by 2025 and (ii) 18-21 year old smokers accounted less than 5% of the group sales.

High inflationary pressure. While the rising input cost has put BAT’s margin under pressure, BAT will mitigate it via two main approaches (i) better innovation and (ii) cost optimization strategy. Increasing ASP is deemed the least preferred option for tobacco players, considering the high price difference between legal cigarettes (RM12-17) and illicits (RM3-9). On the other hand, the uptick in living costs due to the buoyant inflation has resulted in consumers down-trading, both from Premium to AP and AP to VFM. We gather that the combination of higher living costs coupled with the reopening of the international borders might lead to a higher illicit cigarette market share in 2H22.

Forecast. Unchanged

Maintain HOLD, with a TP of RM11.13 based on DCF model with a WACC and TG assumption of 9.5% and 0%, respectively. Despite the group outlook being clouded by the sector's high regulatory risk, the current 12.0x FY23 P/E seems palatable, trading near -1SD of its 5-year average of 15.2x coupled with an attractive DY of >8%.

Source: Hong Leong Investment Bank Research - 29 Jul 2022