BAT’s 1QFY22 results came below expectations, affected by rise in Omicron cases which resulted in consumption contraction. With borders reopened in 2QFY22, this may pose a threat to the group’s earnings as contraband cigarettes may potentially flood the market. Moreover, we expect further challenges ahead given the proposal to ban all kinds of cigarettes products to those born after 2005 plus renewed illicit activities on the aftermath of the proposed banning. We maintain OP with a higher TP of RM13.40 as we roll over our valuation base to FY23E.

Below expectations. 1QFY22 PATAMI of RM52.3m came in below our/consensus estimates of 20%/19% of full-year estimates, respectively. The reason for the negative deviation stems from consumption contraction due to the emergence of the Omicron variant in 1QFY22. The declared dividend of 17.0 sen also missed expectations (vs. our full-year expectation of 90.0 sen), in line with weaker earnings.

Drop in domestic volume. YoY, revenue slid by 8% to RM521.6m due to consumption contraction as a result of the emergence of the Omicron variant in 1QFY22. This resulted in a 7% decline in BAT’s domestic volume, reducing its market share by 0.5ppt YoY. Despite a 2% drop in illicit incidence, legal domestic volume fell by 7% as overall volume was affected by Omicron cases. Duty free sales continued to be impacted by regional and international travel restrictions. Thanks to prior cost rationalisation efforts, the group’s operating expenses fell by 14%, raising EBIT margin by 0.4ppt to 15.7%. All in, the group’s core PATAMI declined by 17% in line with the fall in revenue.

QoQ, revenue slipped by 40% mainly due to the above-mentioned reason along with seasonality pattern in 4QFY21 (1Q historically is a weak quarter) resulting in a 24% decline in domestic volume. On a flip side, Dunhill’s share of premium segment and the group’s Value-for-Money (VFM) share of segment rose to 61.9% (+0.5ppt) and 35% (+0.8ppt), respectively, cushioning the fall in its Aspirational Premium (AP) share of market to 6.8% (-0.8ppt). With the introduction of the route-to-market (RtM) distributor model and continuous efforts in restructuring, the group’s EBIT margin grew by 3.0ppt to 15.7%. Overall, core PATAMI declined by 27% in line with lower revenue.

Battle with the tobacco black market to tighten. Thanks to the stringent measures introduced in Budget 2021 to curb rampant contraband cigarettes, the tobacco black market declined by 6.1% from 2020 resulting in a 5% increase in BAT’s domestic volume. However, the positive turn was short-lived as 1QFY22 saw the illicit market growing by 0.5ppt (vs. FY21) to 57.7%. Therefore, with borders reopened in 2QCY22, this may potentially increase contraband cigarettes in the market which will adversely impact the group’s sales moving forward. Thus, we continue to view that challenges will be aplenty given that contraband remains a significant threat as syndicates continue to find new avenues to smuggle illicit goods. Enforcement activities will likely be lower given the easing of travel restrictions. The government’s recent announcement of its plan to prohibit all tobacco and cigarettes products to those born after 2005 will curb sales and in our view will likely boost the demand for illicit products.

Post results, we reduce our FY22E/FY23E earnings by 3%/6% to account for the potential rise in black market cigarettes, negatively impacting sales moving forward.

Maintain OUTPERFORM with a higher TP of RM13.40 (from RM13.10 previously) as we roll our valuation base to FY23E based on an unchanged PER of 14.2x (0.5SD below its 5-year mean) to account for the aforementioned challenges. However, we maintain the stock at OUTPERFORM on account of its consistent enticing dividend yields of 7%.

Source: Kenanga Research - 30 May 2022