1Q19 Net Profit of RM88.6m (-8%) disappointed on lower volumes and poorer product mix. The 30.0 sen interim dividend declared was as expected. There could be little merit from recovery in overall consumption, despite lower illicit trade proportions (61%). New products to be introduced in the medium term could be positives, awaiting approvals and further product testing. Downgrade to UNDERPERFORM with a lower TP of RM29.55 (from RM32.65).

1Q19 below expectations. 1Q19 Net Profit of RM88.6m is below our/consensus estimates, making up 19%/18% of respective full-year forecasts. The negative deviation was owing to the decline in overall market size, lower premium brand mix and down-trading to lowermargin Value-for-Money (VFM) offerings. An interim dividend of 30.0 sen was declared. We deem this to be within our initial FY19E payment of 155.0 sen.

YoY, 3M19 revenue of RM621.0m was weaker by 3%. Despite some improvement of illicit trade proportions at 61% (1Q18: 63%), total legal industry volumes diminished by 6% to 543m sticks/mth in 3M19. This could be a result of smoking ban in eateries and higher SST-priced products in November 2018, which undermined affordability. This led to poorer demand of premium brands (estimated by -14%), with a consequential down-trading boosting a higher mix of VFM products (estimated at +60% volume; 8% of total group volume, vs 5% in 3M18). Dragged by the lower top-line and poorer product mix, 3M19 net earnings closed at RM88.6m (-8%).

QoQ, 1Q19 sales declined by 19% against 4Q18, led by the similar abovementioned reasons. 1Q19 Net Profit is lower by 24% from lower volumes sold and poorer product mix.

Strains all over. Overall, while it appears that illicit trades are taking a step back from stricter enforcement, the legal market share is also experiencing a decline as higher post-SST prices impairs affordability (with rural areas being a key market for premium brands) and smoking ban at eateries adding to the lower consumption. While regulators believe that clamping down on illicit trade channels could channel purchases to legal duty-paid products, we are not on board with this point of view as affordability was the key reason for the spurt in its market share. In the meantime, management is still in the process of obtaining the pricing approval from regulators for its “heat-not-burn” products to be introduced to the market. Additionally, the group is testing the market reception of its cheaper cigarillo variant in East Malaysia before a larger-scale introduction.

Post-results, we cut our FY19E/FY20E earnings by 11.1%/12.5% to account for more cautious sales volumes and product mix.

Downgrade to UNDERPERFORM with a lower TP of RM29.55 (from RM32.65, previously). We ascribe an unchanged valuation of 20.0x PER (closely in-line with stock’s -1.0SD over its 3-year mean) on a rolled over valuation base-year to FY20E. While the stock could offer fair dividend yield of c.4%, the lack of clear signals of industry volume improvement, stubborn illicit market share and poor affordability are main hurdles to the group’s profitability.

Risks to our call include: (i) faster-than-expected recovery of legal market share, (ii) lower-than-expected conversion towards less premium brands, and (iii) significant decrease in forex to improve cost of sales.

Source: Kenanga Research - 29 May 2019