BAT's FY12 earnings of  RM797.7m  (+10.9%  y-o-y)  were  within  expectations  as subcontract manufacturing's contribution and lower distribution costs lifted profits. Good  news  abound,  as  Dunhill  remained  Malaysia's  favourite  and  dominant cigarette brand, with a 1.6ppt market share increase to 47%. Meanwhile, illicit trade eased  slightly  to  34.5%.  That  said,  we  believe  that  2013  will  be  a  year  plagued  by heightened regulatory risks for the tobacco industry post-general election. Upgrade BAT to NEUTRAL following its share price retracement.

Within  expectations.  BAT  registered  4QFY12  revenue  of  RM1,094.0m  (+10.8%  y-o-y,  -5.7%  q-o-q)  and  earnings  of  RM196.7m (+8.9%  y-o-y,  +5.9%  q-o-q)  as  minimal  trade speculation  in  3QFY12  prior  to  the  2013  Budget  announcement  saw  some  sales  volume spilling over into 4QFY12. In prior years, cigarettes typically experienced a strong uptake in 3Q in anticipation of potential tobacco excise hikes in annual Budgets. Weak sales volume subsequently  follows  in  4Q  as  retailers  gradually  deplete  their  high  stockpiles.  The company's full-year turnover and profits for FY12 clocked in at RM4,364.8m (+5.8% y-o-y) and RM797.7m (+10.9% y-o-y) respectively as marginally stronger volumes, contributions from  subcontract  manufacturing  and  lower  distribution  expenses  boosted  growth.  The year's earnings account for 100.3% of our and consensus estimates.

Dunhill  leads  the  pack.  BAT's FY12 sales volume, measured by  invoiced  sales  to retailers,  rose  by  a  marginal  0.2%  y-o-y,  trailing  the industry's 5.7% expansion. The company's  market  share,  calculated  based  on  AC  Nielsen's  end-user  consumption estimates,  nonetheless  grew  another  1.6ppt  y-o-y  to  62.6%.  Dunhill  led  market  share growth  with  a  2.6ppt  increase  to  47.3%,  further  cementing  it  as  Malaysia's most popular brand.  However,  the brand  with  the  strongest  growth  over  the  past  12  months  was  Philip Morris International (PMI)'s Marlboro Ice Blast, which  propelled the company's volume by double  digits.  This  prompted  Dunhill  to  recently  release  its  own  menthol  switch  cigarette, currently only sold at 7-Eleven outlets.

Illicit  trade  softens.  Stronger  enforcement  by  authorities  saw  illicit  cigarette  trade moderate  by  1.6ppt  y-o-y  to  34.5%  of  total  cigarettes  smoked  in  Malaysia.  Although  illicit trade continues to be elevated, it has been steadily declining over the past three years as the Government froze tobacco excise duty hikes.

Dividends. While FY12 earnings were just a whisker above our estimates, dividends were slightly ahead of our expectations at RM2.72 per share, or at 2.8% of our forecast.

Upgrade  to  NEUTRAL.  We  are  keeping  our  FY13  and  FY14  earnings  forecasts unchanged.  Our  FV  is  hence  maintained  at  RM56.22,  based  on  our  FCFF  valuation (WACC: 5.5%, terminal growth: 1.0%). Following the share price's 10.3% decline since our SELL call, we are upgrading BAT back to NEUTRAL. However, industry growth prospects are weak, with regulatory risks likely to further intensify after the general election.

 Source: OSK