9MFY19 net profit of RM248.0m (-30%) missed expectations as the group continued to be plagued by dwindling market volumes and poorer product mix. While the debut of the group’s “heat-not-burn” products could re-establish its presence in the new market, we do not anticipate meaningful contributions in the near-term. Post-results, we cut FY19E/FY20E earnings by 8%/11% and call to MP with revised TP of RM18.30 (from RM23.10).

Another negative surprise. 9MFY19 net profit of RM248.0m missed expectations at 68%/66% of our/consensus’ full year estimates. The underperformance is largely due to worse-than-expected decline in both industry volume (-4% QoQ) and BAT volume (-8% QoQ), coupled with the continual down-trading to lower-margin Value-for-Money (VFM) offerings. The declared third interim dividend of 29.0 sen (YTD: 85.0 sen) also fell below our FY19E full-year forecast of 121.0 sen, in-line with weaker earnings.

Overall poorer results. YoY, 9MFY19 net profit slipped 30%, mainly dragged by: (i) poorer revenue (-10%) due to affordability issues and the shift in demand towards the growing popularity of vape products, coupled with (ii) thinner EBIT margin (-4.7ppt) on poorer product mix and the absence of GST removal perks. For the individual quarter of 3QFY19, net profit was down by 43% similarly due to the aforesaid reasons.

Sequentially, albeit with revenue falling 9% QoQ, net profit rose by 9%. This stemmed from an improvement in the group’s EBIT margin (+2.6ppt) due to the normalising of marketing expenses from last quarter’s high base following management’s more cautious cost measures.

Relentless challenges. Moving forward, the group are taking initiatives to implement more prudent cost controls, particularly for its marketing spends. Coupled with an expected internal reorganisation coming up between 4Q19 and 1Q20, this could mean lower opex in the coming quarters. Nonetheless, we are of the view that the key challenges to the group remain as follow: (i) the obstinate affordability issue, (ii) illicit tobacco trades (c.65% of entire market share), and (iii) change in consumer preference towards vape products (c.10% of entire market share). Hence, meaningful improvement in its fundamentals would only come from a sustained curb of illegal trades. On the flip-side, we do not expect meaningful contribution from the group’s newly rolled-out “heat- not-burn” products (Glo and refillable Neo sticks) with an expected contribution of < 5% of the group’s sales in FY20.

Downgrade to MARKET PERFORM with a lower TP of RM18.30 (from RM23.10, previously). As we relooked at our valuations and applied a 16x PER (closely in-line with the stock’s -2.0SD over its 3-year mean), we trimmed our FY19E/FY20E earnings by 8%/11% to account for dwindling sales volume and poorer product mix. Despite the stock potentially offering fair dividend yield of c.6% following the recent share price weakness, the lack of clear improvement signals in its operating environment remains a threat.

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) better-than-expected market acceptance for Glo and Neo sticks.

Source: Kenanga Research - 1 Nov 2019