BAT's 9MFY12 earnings were within expectations, with its earnings growing despite softer domestic volume as increased subcontract manufacturing volumes, greater economies of scale and lower compensation provisions boostedprofitability. Despite the stronger industry performance, BAT's 3Q volumes were weaker y-o-y as it faced less trade speculation of an excise hike prior to the 2013 Budget announcement. We are downgrading the company to SELL despite its stellar corporate governance and commanding market share as industry prospects are weak and regulatory risks abound. Dividend yields are at historic lows.
Broadly within expectations. BAT saw its revenue grow to RM1.2bn in 3QFY12 (+5.0% y-o-y, +8.6% q-o-q) and RM3.3bn in 9MFY12 (+4.2% y-o-y) despite domestic net revenue declining by 1.4% YTD. The driver behind the rise is the firm's switch from toll manufacturing revenue recognition previously to subcontract manufacturing revenue recognition in 2012. Turnover from manufacturing for its affiliates within the BAT group will now include both raw material costs and a mark-up, from just a mark-up previously. Revenue growth from the change in revenue recognition methodology will be unsustainable moving into next year. 3Q and 9M earnings clocked in at RM185.7m (+5.3% y-o-y, -15.9% q-o-q) and RM601.0m (+11.5% y-o-y) respectively as higher cost efficiencies from greater economies of scale (production volume, including subcontract manufacturing, grew 26% YTD), a one-time distribution restructuring charge of RM12m in 2011, and lower employee compensation provisions boosted earnings. The 9M bottomline reflects 78.0% and 77.0% of our and consensus full year forecasts.
Volumes weaker on lesser speculation. BAT's domestic cigarette shipments fell 4.9% y-o-y to 2.2bn sticks in 3QFY12 as trade speculation of an excise duty hike prior to the 2013 Budget announcement were lower than 3QFY11. As a result, the company's 9M
shipments declined marginally by 0.7% despite an industry growth of 5.1%. Industry volumes expanded 7.1% in 3Q as BAT's competitors piled up inventory and pushed out more stock to their distributors prior to the unveiling of the Budget.
Dunhill does it again. Market share remained steady q-o-q at 62.7% in 3Q, lifting YTD market share to 62.5% (+1.5ppt vs 2011). Dunhill was the only driver behind the market share increase, with nearly half of the legal cigarettes smoked in the country now being
Dunhill. The brand saw market share gain 2.4ppt to 47.1% YTD. BAT's other brands, in contrast, saw declining market shares. Illicit cigarettes have grown slightly over the past few months to account for 34.9% of total cigarette smoked (+0.2ppt q-o-q).
![](https://research.osk188.com/images/9/uMBu200271645750873e55dca27.jpg)
Government forces higher taxes. We have received greater clarity regarding the higher tobacco-related taxes, which resulted in a RM0.20 per pack price increase since 22 Oct. Although the Government has kept excise duties unchanged at RM0.22 per stick and ad-valorem taxes at 20% of ex-factory price, it has chosen to impose a higher ex-factory price on cigarettes instead of performing a frequent review on the company's manufacturing costs. This will result in higher ad-valorem taxes, persuading BAT to raise its prices. The company has marginally over-covered the higher taxes through its price increase (ie. the additional tax is less than RM0.20 per pack). Although the Government has spoken to all industry players, the other players have yet to reveal the quantum of the ex-factory price increase. JTI and PMI have yet to raise their selling prices.
Downgrade to SELL. We are raising our FY12 earnings forecast by 3.5% despite potentially softer volumes in 4Q as operating expenses were lower than expected. We are however trimming our FY13 estimates by 0.8% on expectations of minor substitution to illicit cigarettes following the 2.0%-2.4% rise in BAT's selling prices. We are hence downgrading BAT to SELL, with our FV revised down to RM56.22 (WACC: 5.5%, terminal growth: 1.0%). The company continues to be one with stellar corporate governance and a commanding market share. However, industry growth prospects are weak, with regulatory risks likely to further intensify after the general election. The firm's dividend yield of 4.1% is the lowest since the turn of the millennium, 1.3ppt lower than the last three-year average of 5.4%. The additional yield above that of the Malaysian 10-year government bond has also narrowed to 0.7ppt from an average of 1.6ppt. The company has declared a quarterly dividend of RM0.65, bringing YTD dividend to RM1.95 per share.
![](https://research.osk188.com/images/10/ghbw109920335150873e562b3b9.jpg)
![](https://research.osk188.com/images/11/BG7p208498747550873e56715d9.jpg)
![](https://research.osk188.com/images/12/v2ap118981727250873e56bc8b3.jpg)
![](https://research.osk188.com/images/13/dZ4r199784001150873e57115cf.jpg)