9M17 CNP of RM419.5m (-19%) was below expectations as sales failed to pick up despite better sentiment. 43.0 sen interim dividend is within expectations. Despite improving legal market share, affordability issue had likely remained a concern. The group have also reintroduced the cheaper “Rothmans” brand of cigarettes to appeal to the price sensitive segment. Post-results, we cut our FY17E/FY18E earnings assumptions by 9.3%/4.3% on lower sales assumptions. Maintain OUTPERFORM with a lower TP of RM45.00.

9M17 core earnings fell below expectations. 9M17 core net earnings of RM419.5m was below expectations, accounting for 67%/66% of our/consensus estimates. The negative deviation was due to lower-thanexpected sales as better consumer sentiment failed to translate to better demand. An interim dividend of 43.0 sen was declared for YTD dividend of 126.0 sen. We deem this as broadly within our 214.0 sen estimate for FY17 as the group typically pay higher dividends during its last quarter.

YoY, 9M17 sales of RM2.3b declined by 21% from a 16% drop in sales volume, resulting from high levels of illicit trade. Discounting the restructuring expenses incurred in the move towards a pure trading business model, the group’s core EBIT declined by 20% to RM553.2m but saw slightly better margins at 24.0% (+0.4 pts) as its manufacturing facilities previously operated at non-optimal levels. The decrease in operating profits further translated to a 19% decline in core net profits at RM419.5m.

QoQ, 3Q17 sales fell slightly by 2% to RM757.3m, despite an improvement in the legal market share to 44% (from 41% in 2Q17). We believe this is due to the affordability issue of non-essential spending still being a concern for consumers, even with supposedly better sentiment readings. Core EBIT margins was lower by 0.8pts to 25.3% to RM191.5m (-5%) as a result of higher marketing spend on the reintroduction of the new “Rothmans” brand which launched in early Oct 2017. Core earnings posted at RM147.5m, which was only weaker by 3% from a lower effective tax rate during the quarter (22.1% from 24.1% in 2Q17).

Better legal market share. The latest data on illicit market share showed the second consecutive quarter of decline to 56%. However, demand still remained soft in spite of better consumer confidence. We believe that this is partly due to tobacco products still being relatively costly for consumers amidst the general rise in the cost of living. Management also cautioned of newer forms of packaging for illegal products that may be more difficult to detect (i.e. fake tax stamps). While talks are ongoing with the regulators for the approval to distribute more affordable, smaller pack sizes, the group has moved to reintroduce an affordable alternative offering via the “Rothmans” brand, which was previously a flagship product, to generate better sales (refer to overleaf). As the group has effectively been transformed into a pure trading company, we believe visibility in margins should at least provide confidence in the group’s performance amidst challenging demand outlook.

Post-results, we cut our FY17E/FY18E earnings assumption by 9.3%/4.3% on lower sales assumption. We also adjust our dividend expectations to 192.0 sen (from 214.0 sen) on reflection of the weaker forecast.

Maintain to OUTPERFORM with a lower Target Price to RM45.00 (from RM47.00, previously). This is based on an unchanged 20.0x FY18E PER (-1SD 5-year mean) which we believe is still fair due to the improving legal market share outlook. Despite only 5.6% capital gain, we believe the OUTPERFORM call is warranted given the strong dividend gains of 5.2% for the stock for FY18.

Source: Kenanga Research - 24 Oct 2017