Period    1Q13

Actual vs. Expectations   1Q13 net profit (“NP”) of RM204.2m was in line with expectations, making up 24.9% of the consensus FY13 forecast of RM820.0m and 25.0% of our RM816.4m estimate.

Dividends     A first interim NDPS of 68 sen was declared, which accounted for 24.3% of our FY13E NDPS of 280 sen (4.5% dividend yield).

Key Results Highlights      QoQ, 1Q13 NP improved marginally by 3.8% despite the marginal revenue growth of 0.2%. This was mainly due to significantly lower operating expenses (-36.7%), which was attributed to the timing of brand marketing and merchandising expenditure. On the flipside, the flattish revenue growth was caused primarily by the lower domestic & duty free volumes, although this was offset by the strong growth in contract manufacturing volumes.

YoY, NP improved by 5.0%, which was in line with sales growth of 5.1%. This was mainly driven by the contract manufacturing of semi-finished goods for exports (Australia, Singapore and Korea), which had a volume growth of 207.6%. The group also achieved a market share of 61.5% (+1.1ppt YoY), led by the strong performance of Dunhill, which saw its market share improve to 47.0% (+1.8%).

Outlook      Although the concerted efforts of the authorities have resulted in an overall decline of illicit trades over the years, they were largely driven by the decrease in illicit kretek cigarettes. In contrast, illicit white cigarettes have been constantly increasing and reached even an all-time high.

Consequently, the overall legal market has been shrinking (estimated at -6.0% YoY in 1Q13 following the October 2012 price increase) due to the growth of illicit white cigarettes, which also competed with BAT's portfolio. Should this worrying trend continue, BAT's domestic volumes could be susceptible despite the group's growing exposure in contract manufacturing.

Change to Forecasts      We maintain our FY13E NP of RM816.4m and FY14E NP of RM876.0m in the absence of a tax hike.

Rating     We are maintaining our MARKET PERFORM rating for now given limited upside to our TP. Although we may see a shift from defensive stocks to high-beta stocks should the uncertainties clear up after the election, we expect the stock to range-bound until such uncertainties will clear.

Valuation       Our valuation of BAT remains unchanged at RM68.40, which is based on a targeted PER of 24x on the FY13 EPS of 286 sen.

Risks      The Government may potentially increase excise duty post the 13th General Elections, which could potentially fuel illicit trade incidences.

Source: Kenanga