1H17 CNP of RM271.9m (-12% YoY) and 43.0 sen interim dividend declared are broadly within expectations. The recent recovery in legal market share (+1%) arising from stringent enforcement to curb illicit during the past several months is a positive development. Better margins from the ceasing of its factory should also support better earnings going forward. Upgrade to OUTPERFORM with a higher TP of RM47.00 as challenges appear to ease.

1H17 core earnings broadly within expectations. 1H17 core net earnings of RM271.9m is deemed broadly within expectations, making up 44%/43% of our/consensus estimates. An interim dividend of 43.0 sen was declared for YTD total dividend of 83.0 sen. We also deem this as broadly within our 214.0 sen estimate for FY17 as we anticipate better payments in the coming quarters on better performing results.

YoY, 1H17 sales of RM1.54b fell by 22% as sales volume dipped by 17% as illicit trade continued to undermine legal demand. Furthermore, no contract manufacturing revenue was registered in 2Q17 following the effective discontinuation of the group’s cigarette production facilities. Less restructuring expenses, core EBIT declined by 18% with the lower operating expenses incurred on the back of the closure of the group’s factory operations. With the lower effective YTD-2017 tax rate of 24% (- 12%) following heavier charges in the 1H16 on significantly larger restructuring expenses, core net profit arrived at RM271.9m (-12%).

QoQ, 2Q17 sales registered flattish growth (<1%). However, not accounting for the group’s ceased contract manufacturing in 1Q17, the group would have recorded a growth of 6% in sales and volume from domestic and duty-free cigarette trade. This could be in part due to the fruition of effective regulatory enforcements in place to curb illicit trade. 2Q17 core net profit registered at RM151.6m (+26%) given the lower expenses incurred from the discontinuation of factory operations.

Meaningful uptick in sight? Recent data on the illicit market share have shown a small but well received improvement to 58% from 59%, marking the first market share decline in 10 months. This could be attributed by more stringent enforcements, which developed in the past several months. While small upticks are anticipated across the coming months, illicit trade is still likely to continue dominating the tobacco industry as high cigarette prices continue to dampen consumer incentives to source from the legal market. However, we expect to see a paradigm shift in the group’s profitability as it moves towards a purely trading-based business model which had already demonstrated meaningful improvements to the group’s operating margins which we have already accounted in our forecasts.

Post-results, we maintain our FY17E/FY18E earnings and dividend assumptions as we believe stronger results could be demonstrated in the coming quarters to make up for the weaker 1H17.

Upgrade to OUTPERFORM as we raise our Target Price to RM47.00 (from RM42.30, previously). This is based on a higher targeted 20.0x FY18E PER (-1SD 5-year mean) from 18.0x FY18E PER (-2SD 5-year mean), previously as we are more positive on the stock given the ease of the headwinds, i.e. lower operational costs that were previously dragged by the plant’s large overhead expenses as well as a potential turnaround in the shrinking of illicit market share.

Source: Kenanga Research - 21 Jul 2017