Quantity Over Quality?

• BAT’s 9M20 core net profit of RM183m (-26% yoy) was below our expectation (69%) but within that of the consensus forecast (74%).
• For 3Q20, top-line sales saw an improvement to RM628m (+7% yoy), but core net profit dipped to RM67m (-20% yoy), likely owing to higher VFM sales, compressing its margins.
• We trim our earnings forecasts by 3.5-6.3% for 2020-22E, inputting higher cost of sales and opex. Despite evidence of recent crackdowns, there are still no signs of illicit incidence subsiding. Maintain SELL with a lower TP of RM9.20.

9M20: Below Expectations

BAT’s 9M20 revenue fell -10.3% to RM1.66bn, on the back of a volume decline of 9% driven by continued legal market volume contraction and lower duty-free sales. Illicit incidence remains rife, growing marginally to 70% (vs 9M19: 69%). Meanwhile, EBITDA margin contracted -2.5ppt to 16.1%, likely in part owing to a higher VFM product mix but slightly offset by cost rationalisation measures. Excluding one-off items (i.e., restructuring expenses), BAT posted a core net profit of RM183.4m (-25.9% yoy). The result was below our expectation (69%) but came in within the consensus forecast (74%). Variance to ours was a mix of higher-than-expected direct cost of goods and operating expenses.

Regaining Market Share But Predominantly on Higher VFM Mix

QoQ, BAT posted a 3Q20 revenue and core net profit of RM628m (+15%) and RM66.8m (+10%) respectively. Revenue trended higher qoq as recovery in volume sales ensued post MCO. We observed that BAT’s domestic volume outpaced that of the industry volume for the second consecutive quarter, reaching a market share of 52.5% (vs 3Q19 50.8%) – aided by its well-received VFM offerings, i.e., Rothmans and Kyo. However, market share expansion came at the expense of margins, and that will likely follow through in the subsequent quarters, given weaker consumer affordability. DPS of 21sen was declared, totalling 56sen for 9M20. (9M19: 85sen).

Maintain SELL

In view of the weaker-than-expected results, we trim our earnings by 3.5-6.3% for 2020- 22E to input higher cost of sales and opex. Post revision, we are keeping our SELL rating on BAT with a lower DDM-derived TP of RM9.20 (from RM9.50). Earnings uncertainty remains elevated at this juncture, hence we believe the risk of capital depreciation still outweighs its dividend yield attractiveness. A key re-rating catalyst for BAT lies in a strong and sustained crackdown on the illicit market, which remains far from being resolved, despite evidence of recent crackdowns

Source: Affin Hwang Research - 30 Oct 2020