During the Budget 2019 speech on Friday, the new Government announced its intent to step up efforts on curbing the rampant illicit cigarette trade, of which they hope to recoup at least RM1bn in tax leakages from. Concurrently, no excise duty hikes were announced. The set of news will spur stronger conviction on BAT’s outlook, and should herald FY19 as the turning point for the company under the Pakatan administration’s commitment. We also tweak FY18-20E EPS to reflect the SST-led price hike at RM0.40/pack for BAT’s brands, which was announced shortly after the Budget. Reiterate our BUY recommendation with a higher CY19E DDM-derived TP of RM40.20.

A First-ever Mention of Illicit Trade Clampdown in the Budget

The Government’s desire to recover at least RM1bn in tax leakages is a strong statement of intent, which would imply 2.5bn cigarette sticks or 15ppts recoup in legal market share from YTD illicit market share of 63%. While we had earlier anticipated a proclamation of action against the illicit trade as well as a rain-check on raising excise duties this year, we conservatively assumed an 8ppts legal market share gain in FY19 in our forecasts. The ban on smoking at outdoor eateries was also formally announced during the Budget speech starting 1 January 2019, of which we are largely neutral towards while awaiting further details on its implementation process.

Price Hike Issue Resolved

Subsequent to the Budget announcement, BAT also announced the official SST-driven price hike for their cigarette brands at RM0.40/pack or 2.4%- 3.3%, effective immediately. We earlier mentioned that the price hike, at such levels, would be able to protect margins without causing a shock to volume sales, in our view. The quantum of price hike for the other tobacco players should also be revealed soon.

Maintain BUY

We tweak FY18-20E EPS higher by +0.5%/+3.1%/+3.1% after pricing in gross margin improvement from the price hike. The set of news should act as a re-rating catalyst for the stock, which remains largely below its fair value, while offering attractive yields of 4.4%-6.3%. Reiterate our BUY call on BAT, with a revised 12-month DDM-derived TP of RM40.20. Downside risks: i) slower-than-expected enforcement activities; and ii) aggressive excise duty shocks.

Source: Affin Hwang Research - 5 Nov 2018