BAT’s 1Q19 core earnings declined 8% yoy, coming in below our and consensus expectations (17%/18% of full-year forecasts). The dip was attributed to lower volume sales following consumers’ initial reaction to last November’s SST-led price hike, alongside the eateries smoking ban in January. However, the bright spot was a 2ppts decline in illicit cigarettes’ share in 1Q19, although still falling short of our expectation for a 3-4ppts drop. Despite our earnings cut to factor in downtrading and lag in volume recovery, we nonetheless remain positive on BAT’s outlook. Reiterate BUY, with a revised TP of RM39.70.

Both Legal and Illicit Volumes Declined

1Q19 core net profit was lower at RM88.6m (-7.9% yoy), as volume sales fell by 9.6%, in tandem with the legal market’s contraction (-6% volume yoy) as smokers reacted to the smoking ban at eateries nationwide as well as SSTled price hike. Because of that, BAT was not able to benefit from the -2ppts yoy decline in illicit cigarettes’ market share in 1Q19 to 61%, a level last seen in 3Q17. Rather, the group took a larger hit on sales vis-à-vis its peers while being the market leader overall as well as within the premium segment. This was also partly due to further downtrading occurring during the quarter, which hence explains the slight margin compression.

Awaiting Final Approval for the Launch of Glo

Management has expressed ongoing delay with pricing approval by the MOH for BAT’s heated tobacco refills (‘Neo’), in order to launch its long-awaited Glo, the group’s heat-not-burn (HNB) device. Nevertheless, we expect the approval to come through in the coming months, as we gather that the Neo sticks are classified and priced similarly to Philip Morris’ Heets sticks. Meanwhile, we remain alert on other alternative products in the market such as new-generation, compact vaping devices which appear to be gaining traction with the young crowd.

Maintain BUY

We cut our 2019-21E EPS by 13%/6%/2% respectively, after factoring in additional downtrading as well as slightly slower illicit trade reduction over 2019-20E while the authorities catch up to the syndicates’ fluid operations. All in, we remain positive on BAT, while continuing to foresee progressive improvements in the coming quarters. Reiterate BUY, after rolling forward our valuation horizon, to a 2020E DDM-derived TP of RM39.70. Downside risks: i) slower enforcement activities; ii) aggressive excise duty hikes; and (iii) heightened competition from alternative products.

Source: Affin Hwang Research - 29 May 2019