• BAT escaped a challenging 2Q20 unscathed on a qoq basis, with revenue and core earnings growing 14% and 10% respectively to RM547m and RM61m.
• Nonetheless, 6M20 core earnings have declined by 29% to RM116m (above our and consensus expectations) owing to continued volume contraction, market down-trading and lower duty-free sales.
• While we lift our TP to RM9.50 post-earnings revisions, we maintain our SELL rating as we are not fully convinced of a sustainable turnaround in the legal industry volume and given the frail macro backdrop amid Covid-19 concerns.

Stronger qoq performance a positive surprise

BAT escaped a challenging 2Q20 relatively unscathed on a qoq basis, with revenue and core earnings growing 13.6% and 9.6% respectively to RM546.6m and RM60.7m, in tandem with the overall industry volume growth of 10% qoq (increased spending due to the Raya festive season & higher disposable cash at hand). BAT’s domestic volume growth of 15% outpaced the industry growth, on an agile response to replenish stock within the first week of operations in May and more targeted distribution post-MCO.

6M20 core net profit at RM116.1m, down 29.1% yoy

Nevertheless, 6M20 revenue declined by 18.5% to RM1.03bn, owing to continued volume contraction (-18% yoy), market down-trading and lower duty-free sales. With an EBITDA margin contraction of 1.5 ppt, core net profit came in at RM116.1m (-29.1% yoy). As 2H20 is expected to fare better HoH, we deem the earnings above our and consensus expectations, accounting for 46-45% of the full-year estimates. The variance to ours was due to stronger-than-expected 2Q volume sales. BAT declared a second interim dividend of 18sen, bringing the total DPS to 35sen (6M19: 56 sen).

Decent 2Q, but underlying illicit trade issue remains

The total legal industry volume declined by 6% to 505 sticks/month in 6M20 (vs 6M19: 536) as the black market share continued to hover at 69% in spite of heightened enforcement activities. For 2H20, management’s focus continued to revolve mainly around initiatives to eradicate the illicit market, through public awareness campaigns and active engagement with relevant authorities. Meanwhile, the group has extended its VFM offerings through a new brand “KYO” which was launched on 1 July 2020. The retail price for “KYO” is RM11.50, representing a 34% and 8% discount to BAT’s existing premium (Dunhill RM17.50) and VFM (Rothmans RM12.50) brands. The launch of “KYO” is timely, in our view, given the stretch in affordability and increased down-trading by consumers.

Maintain SELL with TP of RM9.50

In view of the decent set of results, we lift our earnings forecasts by 5.5%-5.6% for FY20-22, broadly to account for better FMC sales volumes. Nevertheless, we are keeping our SELL rating post the revisions, albeit with a higher 12-month DDM-derived TP of RM9.50 (cost of equity: 10.2%; TG: 1%). While we are encouraged by the decent 2Q results, the strong increase in the legal industry volume qoq is likely a one-off, in our view, given that the illegal cigarette trade may have been partially restricted during the MCO. Thus, we are not fully convinced of a sustainable turnaround in the legal industry volume, with the illegal cigarette trade remaining stubbornly high and given a frail macro backdrop on lingering Covid-19 concerns. Upside risks: (i) better-than-expected enforcement outcomes, (ii) excise-duty hike reversals and (iii) abating competition from alternative products.

Source: Affin Hwang Research - 23 Jul 2020