Widened crackdowns by the authorities appear to have curbed the illicit trade slightly, and have even pushed some smokers back to the legal value-for-money (VFM) products. BAT acknowledged that its VFM range is underperforming its peers and has plans to address the issue. We maintain our forecasts, TP of RM12.00 and MARKET PERFORM call.

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

1. FY22 sales volume remained largely flat after adjusting for a change in route-to-market method. In essence, the group now recognises the sale of inventory at the distributor level instead of at final sale as done previously. The group implemented this change in 4QFY21 and after adjusting for the one-off gain in volume at that point, demand remained relatively stable during FY22. Product mix was also mostly maintained, with revenue falling in line with the reduced pre adjustment volume.

2. Illicit market share fell to 56.6% in FY22; a 0.6ppt fall from FY21. 4QFY22 illicit incidence also fell QoQ from 56.1% to 54.8%. Additionally, the group commented that while government regulation has been able to combat the black market from the supply side, demand for illicit cigarettes remains high due to the price gap between them. The group also shared that government intervention has been largely focused on the cheaper illicit market (below RM6) and that higher priced black-market cigarettes (RM6-RM10) have gained market share.

3. The group managed to claw back about 70% of the market share lost after delisting Pall Mall and Kent. While the premium and value-for money segment grew marginally YoY, its mid-range segment contracted by 2.8ppts in FY22. Furthermore, the group commented that due to the widened crackdown on cheap illicit cigarettes, some smokers have returned to the legal VFM products. It also guided that its own VFM range is underperforming relative to the rest of the market and it is addressing the issue.

4. The group has relaunched its tobacco heating product Glo during February 2023. However, it expects impact on earnings to be largely immaterial given the limited scope of the launch. Additionally, the group guided that margins for the Viio tobacco sticks are similar to its mid-range products. Thus, despite the absolute price of RM12 being lower than the VFM products, margins would actually improve if consumers shift to their THP line. Additionally, the group is not concerned over products cannibalisation as the market for alternative tobacco products is already largely developed.

Maintain MARKET PERFORM with an unchanged DCF-derived TP (WACC: 8.1%, TG: -2%) of RM12.00. 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 8.3%, we also see limited overall prospects given the high interest rate environment.

We continue to like BAT for its: (i) relatively stable demand in the medium term following the economy 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, commanding 51.6% of the legal market share. However, we remain wary of the lack of catalysts for longer term growth 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 - 17 Feb 2023