1QFY20 CNP of RM55.0m (-37.9% YoY) missed expectations on dwindling market volumes and poorer product mix. Moving forward, we anticipate affordability issue to continue clouding its outlook, which may be further exacerbated by the worsening economic conditions amid the pandemic outbreak. Downgrade to UNDERPERFORM with lower TP of RM10.05 (from RM15.50) as we cut FY20E and FY21E earnings by 35.1% and 32.1%, respectively.

Missed expectations. 1QFY20 core net profit (CNP) of RM55.0m (after accounting for RM4.2m restructuring expenses) came in below expectations at 16% and 17% of our and consensus’ full-year estimates, respectively. We believe the shortfall is mainly due to the worse-than-expected contraction in product volume (-18% YoY, -24% QoQ). The declared dividend of 17.0 sen also missed expectation, inline with weaker earnings.

Poorer results overall. YoY, 1QFY20 revenue dropped by 22.5%, no thanks to the continual shrinkage in legal market volume (-11%) and BAT product volume (-18%) due to affordability issues as well as a shift in demand towards illegal vaping products. Furthermore, the group’s duty free business (c.4% of total revenue) was heavily impacted by the fall in passenger traffic during the pandemic outbreak, which also contributed to the decrease in revenue. Consequently, CNP fell by 37.9%, dragged by poorer product mix as smokers traded down to lower-margin value-for-money (VFM) product (i.e. Rothmans).

QoQ, 1QFY20 revenue and CNP plunged 27.4% and 51.4%, respectively, similarly due to the foresaid reasons. Notably, it appears that the group’s restructuring and cost-savings exercises have yet to bear fruits, as the EBIT margin (-7.5ppt QoQ) continued to be pressured by revenue loss and continuous investment cost in the product portfolio.

Illicit trades continue to take the centre stage. Moving forward, the group’s outlook seems to remain bleak, as the economic impact from the pandemic outbreak is likely to have a prolonged effect on its profitability by aggravating its already harsh operating environment. Weaker purchasing power caused by a disrupted economy may very well exacerbate the issue of affordability, and divert smokers to illicit cigarettes (currently taking up c. 69% of market share). Moreover, the illegal cigarette syndicates have proven to be more resilient than expected, as we gathered that they have made further in-roads in spite of the MCO (i.e. by distributing within 10km radius, selling online and delivering via courier). Therefore, we maintain our view that any meaningful recovery would only materialise with a sustained clampdown on illegal cigarettes.

Post-results, we slashed our FY20E and FY21E earnings by -35.1% and -32.1%, respectively, as we take into account the dwindling sales volume.

Downgrade to UNDERPERFORM with a lower TP of RM10.05 (from RM15.50). We ascribed an unchanged valuation of 13.0x PER (closely in-line with the stock’s -2SD over its 3-year mean) on a rolled forward valuation base year to FY21E. Despite the stock offering a fair dividend yield of c.5.6%, the lack of visible improvements in the operating environment remains a threat. Risks to our call include: (i) lower-thanexpected operating expenses and (ii) stronger-than-expected product volume.

Source: Kenanga Research - 22 May 2020