BAT’s FY17 core earnings declined by 25.7% yoy to RM502m, excluding the impact of one-off restructuring expenses. This came in below our and consensus expectations, accounting for only 85% and 88% of FY17 estimates respectively. The disappointment in 4Q17 was attributable to a contraction of the legal market, provision for impairment of prepaid excise duties, and lower profitability of VFM. With lower-than-expected gross margin arising from higher contribution of Rothmans, we cut our FY18E-19E EPS by 8-14%. Maintain HOLD with a lower TP of RM34.

4Q17 Earnings Below Our and Consensus Expectations

4Q17 revenue decreased by 18% yoy as cigarette volumes dropped c.14% yoy and coupled with higher contribution from the lower ASP VFM segment. Since the launch of Rothmans (RM12/pack) in Oct 17, its contribution had risen to 5% of BAT’s volume mix, resulting in gross margin dilution to 31% (vs. 31.9% in 4Q16). Also, BAT made a provision of impairment of prepaid excise duties of RM21m that is pending refund from Royal Malaysian Customs (RMC). Dunhill’s mix has dropped to 71% in FY17 from 74% in FY16. As a result, 4Q17 core net profit came in at RM82.42m (-48% yoy), bringing FY17 core net profit to RM502m (-26% yoy). This was below our and consensus expectations. The Group declared a 4th interim DPS of 43sen, bringing total FY17 DPS to 169 sen (vs. FY16: 278 sen).

The Return of Illicit Cigarette in 4Q17

After 2 quarters of contraction, the illicit market grew by 1.7ppts to 59% in 4Q17. As a result, the legal market’s volume declined by 3% qoq. However, BAT’s volume declined at a lower rate of 1.1% qoq due to the launch of Rothmans, maintaining BAT’s market share at 53.9% in 4Q17.

Maintain HOLD Rating With Lower DDM-derived TP of RM34

We introduce out FY20E EPS estimate but reduce our FY18-19E EPS by 8-14% to factor in lower PBT margin arising from higher contribution of VFM segment given that a RM12/pack Rothmans may potentially further cannibalize BAT’s premium brands. We maintain our assumptions that the legal cigarettes’ market share stabilizes at c.57% while BAT maintains its market share at 55% on the back of VFM products. Upside risks: strongerthan-expected sales volume and lower-than-expected operating expenses. Downside risk: excise hikes.

Source: Affin Hwang Research - 13 Feb 2018