Period     2Q13 / 1H13

Actual vs. Expectations  Net profit (“NP”) of RM415.0m for 1H13 came in within expectation, at 50.8% of our full year forecast of RM816.4m and 50.3% of the consensus estimates of RM825.4m.

Dividends    A second interim NDPS of 68 sen was declared as expected. Plus the first interim dividend, this comes to a total of 134 sen, or 47% of our FY13E NDPS of 280 sen (representing a full year dividend yield of 4.7%).

Key Results Highlights     QoQ, the NP improved by 3.2% in 2Q13 on the back of a 5.6% increase in revenue. While the higher domestic volumes had led to a slight gross margin improvement (0.13ppt), this was diluted by an increase in operating expenses incurred during the quarter (15.7% higher than 1Q13) as a result of higher merchandising and market share scheme costs.

YoY, the NP declined 4.5% despite the high single digit revenue growth of 8.3%. The increase in revenue was mainly driven by the higher contract manufacturing volumes (40.5% increase in YoY volume) which was able to offset the decline in domestic & duty free market volumes (1.8% decrease in YoY volume). However, given that contract manufacturing margins remain significantly lower than the domestic and duty free market segments; this had negatively affected BAT's product mix and translated to a 1.99ppt YoY decline in gross profit margin.

YTD, BAT reported a 1H13 revenue growth of 6.7% while net profit declined marginally by 0.1%. YoY,  BAT had further strengthened its market leadership with a 1.0ppt growth to 61.5%. Dunhill remained the key driver of this growth, with market share increasing 1.7ppt to 47.1%. However, the strong growth was partially offset by aggregate declines across the rest of the portfolio by 0.6ppt.  

Outlook    Although efforts by the authorities have resulted in an overall decline of illicit trade since 2009, they were largely driven by the decrease in illicit kretek while illicit white cigarettes have simultaneously increased to an all-time high of 23.6% in 2012. There was a decline in legal market consumption as well, due to the increased competition from these illicit white cigarettes. 

Nevertheless, concerted efforts to launch new products such as Dunhill Ice (1Q13) as well as initiatives like the new RELOC seal design (4Q12) and Dunhill Switch reinforcement campaign (4Q12) have aided BAT in capturing a larger market share. BAT’s exposure in  the fast-growing  Contract Manufacturing segment would also provide an added buffer to the potential legal market shrinkage. 

Change to Forecasts  We maintain our FY13E NP of RM816.4m and FY14E NP of RM876.0m respectively.

Rating   We are maintaining our  MARKET PERFORM rating given the limited upside to our TP. 

Valuation     Our valuation of BAT remains unchanged at RM61.36, which is based on a targeted PER of 20x on the FY14 EPS of 306.8 sen.

Risks    An increase in excise duty could fuel more illicit trade.

Source: Kenanga