BAT’s earnings momentum remained strong. 3Q18 earnings rose by 32% qoq to RM145.8m while gross margins leapt 6.6ppts, primarily driven by front-loading of sales over the remaining July-Aug GST-free period as speculation mounted on the SST’s price impact. Consequently, 9M18’s results stood above our expectations but tracked consensus estimates. Market share of illicit cigarettes also fell marginally during the quarter (from 63% to 62%), tying in with our view that the illicit trade has stagnated. Reiterate BUY with an unchanged CY19E DDM-derived TP of RM39.10.

Above Expectations

BAT’s 9M18 core net profit declined by 16.1% yoy to RM352m, due to lower sales (-8% yoy) as the illicit market rose 3ppts to 63%, while margins contracted due to a shift in portfolio mix towards value-for-money (VFM) Rothmans cigarettes. Overall, the results were above our expectations, accounting for 82% of our full-year estimates. The surprise was largely down to 3Q18’s RM10m collection of tax stamp provisions, as well as frontloading of sales over the 2 remaining zero-GST months which saw BAT collect an additional RM27m in GST benefits due to restrictions on rolling back of cigarette prices in the absence of GST tax charges. We gather that the front-loading was concentrated on fast-moving premium Dunhill, as retailers stocked up amidst uncertainty over cigarette products’ re-pricing subsequent to SST’s implementation.

Discussion Underway With Health Ministry on Post-SST Price Hike

The Health Ministry is working on formalising higher prices for cigarettes following SST’s implementation which are set to kick in by November. Management has yet to propose a price hike quantum for its products, while awaiting MOH’s final approach towards SST’s treatment. BAT has contended MOH’s initial price hike interpretation of RM1.00/pack which was supposedly premised on moving from the zero-rated GST holiday onto the 10% sales tax regime, instead of from the original 6% GST rate.

Maintain BUY

We leave our earnings forecasts unchanged for now while awaiting MOH’s formalisation of the price hike on cigarettes. Our positive view on BAT remains intact as we expect a tougher wave of enforcement activity to come through soon on the illicit cigarettes trade. We hence reiterate our BUY call on BAT with an unchanged 12-month DDM-derived TP of RM39.10. Downside risks: i) slower enforcement activities; and ii) aggressive excise duty hikes and new taxes

Source: Affin Hwang Research - 22 Oct 2018