BAT has guided that the group will be renewing focus on their premium Dunhill brand in an effort to regain market share. While its premium and value-for-money (VFM) brands have grown marginally, it has lost overall market share following the contraction of their mid-range offerings. Otherwise, the group is largely positive on the proposed increased regulations in Budget 2023 to curb the black market. Maintain forecasts, TP of RM11.45 and MARKET PERFORM call.

We attended BAT’s analyst briefing and the key takeaways are as follows:

1. The group guided that they will be renewing focus on its premium segment in an attempt to claw back some market share. Its Dunhill brand currently holds a majority of premium market share at 63% as of 3QFY22. A majority of the loss in its market share is within their mid-range segment (-3ppt YoY), partially due to the delisting of its Pall Mall and Kent brands.

2. Illicit volume saw a downtick from 57.7% to 56.1% in 3QFY22 following an increase in inland seizures during the period. Renewed efforts by law enforcement have successfully cut supply for the black market, resulting in the fall in illicit trade.

3. The group is largely positive on the measures proposed by the incumbent government under Budget 2023 to curb smuggling. The group says the measures under the Multi Action Task Force are in line with those proposed by BAT during its previous meetings with government officials. Conversely, the group is not immediately concerned with the proposed generational ban on cigarettes and vapour products as the bill will need to be re-tabled following the election.

4. The group has largely contained the rising cost of production so far via their parent company’s global supply chain. Per their guidance, procurement of raw materials through the larger group’s channels has allowed for better economies of scale, minimising the effect of rising material prices and distribution costs so far. Additionally, barring an excise increase, the group has guided that raising prices will be a last resort to contain any cost pressure. The group has guided that while any excise increases will be borne by the consumers, its effective ability to pass through costs is limited due to competition from the black market. During the last direct excise increase in 2015, illicit volume spiked from around 35% to 60% following the price increase.

Maintain MARKET PERFORM with an unchanged DCF-derived TP (WACC: 8.1%, TG: -2%) of RM11.45. We also apply a 5% discount based on a 2-star ESG rating as appraised by us. While the stock may appeal to yield seekers due to its high dividend yield of 8.7%, we also see limited prospects given the rising interest rate environment.

We continue to like BAT for its: (i) relatively stable demand in the medium term following the economic reopening, (ii) leading position in the high-margin premium cigarette segment with its Dunhill brand, and (iii) market position as the largest player within the legal tobacco market, holding 51.5% of the legal market share. However, we remain wary of the lack of catalysts for longer term growth as well as rising health consciousness dampens demand.

Risks to our call include: (i) more restrictions on the sales of tobacco products, (ii) higher excise eating into demand, and (iii) illicit trade eating into the legal market.

Source: Kenanga Research - 21 Nov 2022