• BAT’s VFM offerings have by and large seen a good traction, and are poised to provide a steady earnings base for the group moving forward.
• Pronounced measures laid out in Budget 2021 are likely to remain supportive of near-term sentiment. For every 1% reduction in illicit volumes, the impact to the 2021E earnings is +3%, based on our estimates.
• We revise higher our earnings forecasts for 2021-22E by 9-18%, inputting higher VFM volume sales. Further upside risk may transpire from the reduction in illicit volumes. Upgrade to BUY, with a higher TP of RM16.20.

Steady earnings base from VFM offerings

The previous two quarters saw BAT’s domestic volume increase 15% / 14% qoq for 2Q20 / 3Q20, outpacing the industry’s growth of +10%/+7% qoq. This led to a market share gain of 2.1ppt to 52.5% over the period. Much of the volume improvement could be attributed to VFM offerings, Kyo and Rothmans, which garnered strong traction on the back of increased down-trading towards more economical variants. Notwithstanding the lower-margin nature of VFM offerings, we expect the growing volume sales to offset the lower profitability, and support sequential earnings improvement

Reduction in illegal volumes is an added bonus

Limiting the transhipment of cigarettes to dedicated ports and the initial imposition of import taxes are seen as keys to eliminate a major loophole in the tobacco black market. It is believed that 30-40% of illegal volumes are brought in via transhipments. Hence, if successfully executed, a blue-sky scenario would imply an elimination of almost c.4.5bn illegal cigarette sticks per year. For every 1% reduction in illicit volumes, we estimate an increase in the 2021E net profit of around 3%.

All-round positive developments; upgrade to BUY

We revise up our earnings estimates by 9-18% for 2021-22E, largely inputting higher VFM sales. Meantime, we lowered our CoE assumption to 8.2% (from 10%), reflecting the prospects of better containment of the illegal market, and gradual return to normalcy in 2021. Since the announcement of Budget 2021, BAT’s share price has appreciated by c.37%, largely as investors have turned more upbeat on prospects of better control of the illegal tobacco market. We foresee further upside from the current juncture, and hence upgrade the stock to BUY with a higher DDMderived TP of RM16.20.

Source: Affin Hwang Research - 9 Dec 2020