9MFY20 CNP of RM183.1m (-26% YoY) came in above our expectation but within consensus, due to sustained Dunhill sales and growth from its VFM segment. Post-results, we bumped FY20E/FY21E earnings up by 9.8%/12.5%, and raised the stock to OUTPERFORM with a higher TP of RM11.05. While we note that the group’s outlook remains clouded by the raging illicit market, current valuations appear undemanding at 11.4x FY21E PER. Coupled with a generous dividend yield of c.8%, the stock serves as an attractive dividend play.

Beats our expectation, but within consensus. 9MFY20 core net profit (CNP) of RM183.1m (after accounting for RM14.0m restructuring expenses) came in above our expectation at 83%, but within consensus at 74%. The mismatch is likely due to stronger-than-expected revenue growth in 3QFY20, attributable to steady Dunhill sales coupled with its Value for Money (VFM) segment charting good progress. The declared dividend of 21.0 sen (YTD: 56.0 sen) is deemed to be within expectations.

Black market continues to haunt. YoY, 9MFY20 revenue continued to see a decline of 10%, mainly dampened by: (i) rampant illicit market volume at 70% (versus 69% in 9MFY19), (ii) persistent shrinkage in BAT product volume (-9%) due to the shift in demand towards illegal trades, as well as weaker duty-free sales amidst the Covid-19 travel restrictions. Subsequently, CNP fell by 26%, as core EBIT margin (- 2.9ppt) remains pressured by down-trading to lower-margin VFM products (i.e. Rothmans and KYO). The slimmer margin was slightly supported by the group’s cost rationalisation exercise, which led to a 5% fall in opex YoY.

Stronger QoQ. On the force of stronger BAT domestic volume (+14%) which outperformed the market volume growth (+7%), 3QFY20 revenue grew by 15%. While the industry growth was largely driven by sales normalisation post lockdown, BAT’s volume growth was attributed to sustained performances from its Premium segment (i.e. Dunhill) and stronger VFM segment, which were boosted by the new inclusion to the portfolio (i.e. KYO brand which was launched in June), nudging CNP to record a growth of 9%.

Not out of the woods yet? While we note the group’s encouraging effort to capture the down-trading market share via the inclusion of KYO, the operating environment remains harsh for the group against the backdrop of a dwindling industry volume and poorer product mix, which could only lead to thinner margins. Weaker purchasing power caused by a Covid-19-disrupted economy may also very well exacerbate the issue of affordability, further diverting smokers to illicit cigarettes and vaping products. Therefore, we maintain our view that any meaningful earnings recovery would only materialise with a sustained clampdown on illegal cigarettes (which currently takes up c.70% of market share).

Post-results, we bumped our FY20E and FY21E earnings upwards by 9.8% and 12.5%, respectively, by pencilling in more generous assumption for product volumes growth. NDPS were also adjusted upwards accordingly to 80.0 sen and 82.0 sen, respectively, by maintaining a pay-out assumption of 94%.

Upgrade to OUTPERFORM with a higher TP of RM11.05 (from RM10.05) following the earnings upgrade. Our TP is based on an unchanged valuation of FY21E PER of 13.0x (closely in-line with -1SD over the 3-year mean). The current valuations appear undemanding @ 11.4x FY21E PER (close to -1.5SD), which may have abundantly priced in the depressed operating environment and lack of visible earnings prospect ahead. With that, the stock serves as an attractive dividend play, offering yield of c.8% which could offer some comfort amid the volatile market environment. Risks to our call include: (i) lower-than expected dividend pay-out and (ii) weaker-than-expected product volume.

Source: Kenanga Research - 30 Oct 2020