On the back of multiple vaping-related deaths and illnesses alongside an epidemic of youth usage reported in the US, its authorities are planning an imminent ban on the sale of all flavoured non-tobacco vape products in the country. Given the mounting health concerns, we believe this could arrest the surging local usage of vape products in the near-term. In tandem, this may benefit cigarette volumes and position heated tobacco products such as iQos and BAT’s upcoming Glo as safer smoking alternatives. As PER are <-2SD historical mean and given increased probabilities of dividend yields sustaining at >6%, risk reward looks favourable. Upgrade BAT to a BUY (from Hold).

US Vape Ban Prompted by Alarming Health Cases, Underage Usage

The move by the US authorities came about as 450 cases of pulmonary illnesses linked to the usage of vapes sprouted nationwide in the past several months, including six deaths reported since August. This was accompanied by the US Food and Drug Administration (FDA)’s latest survey data which underscored the prominent rise of underage vaping – over a quarter of American high school students being active vape users, up from 20.8% in 2018. We gather that all flavoured vape products, aside from tobacco-flavoured ones, would soon be removed from US retail channels Until – and If – They Receive Subsequent Authorisation From the FDA.

Domestic Situation Resembling That of the US

The public and local health authorities’ concerns over vaping’s health risks and teen usage are likely to escalate locally, given its similar situation to the States. Unregulated new-generation vape products, most of which are nicotine-filled, have proliferated and are now estimated to account for an equivalent of 8-10% of Malaysia’s tobacco consumption – magnifying the issue of illegal smoking consumption (combined vaping and illicit cigarettes market share of 70%), while also nullifying a recent decline in smuggled cigarette volumes due to stricter enforcement activities by local authorities.

A Relief for the Legal Tobacco Industry?

Rising local awareness on the dangers of illicit nicotine products and looming oversight on vape and shisha products could disrupt the burgeoning vape market, and in turn potentially benefit the legal tobacco players’ cigarette volumes and reception of heat-not-burn products such as iQos and BAT’s Glo (launching in 4Q19). However, the former would be dependent on positive outcomes arising from the enforcement of illicit cigarettes and fake tax stamps, while the latter could be offset by stricter compliance requirements, amid the e-cigarette health crisis.

Upgrade to BUY on Valuation Grounds

Following the recent collapse in BAT’s share price – after its disappointing 2Q19 results hamstrung by the rise in fake tax stamps and vape products – to a 20-year low, the risk-reward has once again turned favourable in our view. Even after trimming our 2020-21E earnings by 5-6% to reflect our expectations of higher A&P and compliance costs due to Glo’s introduction to the market, PER valuations are at multi year lows (<-2SD historical mean). As such, we upgrade the stock to a BUY (from Hold) albeit with a lower DDM-derived TP of RM27.80 (from RM30.00). Attractive dividend yields of 6.2%-7.1% are also on the cards at current levels. Downside risks: (i) weaker-than-expected enforcement outcomes; (ii) heightened competition from alternative products; and (iii) resumption of excise duty hikes.

Source: Affin Hwang Research - 13 Sept 2019