BAT’s 2018 results came in within our and consensus expectations. Core earnings declined 14% yoy as sales volume again suffered from the rampant illicit cigarettes trade. Market conditions have nonetheless stabilised in 2018, and the worst is likely to be over, in our view. We continue to favour BAT’s recovery prospects in 2019, spurred by the government’s mounting pressure against the untaxed illicit market. Reiterate BUY with an unchanged TP of RM40.20.

Ending Within Expectations

BAT’s 2018 core net profit declined by 14% yoy to RM449.2m amid higher incidence of cheap illicit cigarettes in the market (63% of market vs. 61% in 2017). Sales volume declined 4.6% yoy while margins were impacted by the introduction of value-for-money (VFM) Rothmans cigarettes. Overall, the results were within both our and consensus expectations, accounting for 104% and 101% of 2018 estimates. A fourth dividend of 47sen was declared, bringing full-year DPS to 155sen (FY17: 169sen). There were positive signs for BAT, including a stabilising illicit market over 2018 following its shocking rise during 2015-17. In the legal market, BAT retained its leading share of 56.3%, led by premium Dunhill’s strength. Meanwhile, management expects only a marginal impact on volumes following the smoking ban at eateries.

Expecting a Turnaround Year

Going into 2019, we turn more positive on BAT’s earnings recovery prospects, fueled by the Government and Customs’ intensifying efforts to stifle the illicit cigarettes trade and recover at least RM1bn of tax leakages. We believe that escalating pressure – significantly heavier penalties, increasing number of raids, joint-agency coordination – on the illicit activities would over the year lead to a meaningful reduction of contraband cigarettes. On the heated tobacco segment, management is also working on bringing in its heat-not-burn ‘Glo’ device into the market.

Maintain BUY

We leave our earnings forecasts largely unchanged, while introducing our 2021E EPS forecasts. BAT’s recovery prospects remain very much upbeat, in our view. Hence, we reiterate our BUY recommendation on BAT, with an unchanged 12-month DDM-derived TP of RM40.20. Downside risks: i) slower enforcement activities; ii) aggressive excise duty hikes; and (iii) heightened competition from heated tobacco products.

Source: Affin Hwang Research - 22 Feb 2019