Maintain HOLD with higher DCF-TP of MYR10.25

3Q20 results were above expectations given higher-than-expected sales volume as business activity resumed after the initial stages of MCO. We raise our FY20 earnings estimate by 11% but leave FY21-FY22 earnings estimates unchanged. As risks of growing illicit share and consumer down-trading continue, we believe that outlook remains challenging for the tobacco industry. Maintain HOLD with a higher DCF-TP of MYR10.25 (WACC: 9.5%, LT growth: 1%).

Results above expectations on higher sales volume…

BAT’s 3Q20 core net profit of MYR67m (-20% YoY, +9% QoQ) brought 9M20 core net profit to MYR183m (-26% YoY). The latter accounted for 83%/74% of our/consensus full-year earnings estimates. The beat was due to higher-than-expected gross profit margin given better sales volume. BAT announced a third interim dividend of 21sen/shr which brings YTD dividend to 56sen/shr, within expectations at 95% DPR.

…but no reprieve from high illicit cigarette share

3Q20 revenue grew 15% QoQ mainly due to BAT’s 14% QoQ improvement in sales volume growth (vs. industry volume growth of +7% QoQ) given promising product market share in both its premium (64%, flat QoQ) and its value-for-money (VFM) categories (35.8%, +5.6ppts QoQ). Note that higher VFM sales volume was in conjunction with BAT’s new brand launch ‘Kyo’ in Jul 20. BAT’s overall market share also improved to 52.5% (+1ppts QoQ). 3QFY20 EBIT rose 6% QoQ but EBIT margins declined by 1.3ppts QoQ given consumer down-trading to the VFM category. Negatively, illicit cigarette share has risen to 64.5% (+4ppts QoQ) despite an increase in enforcement efforts thus far.

Inherent industry risks remain

We raise our FY20 earnings estimate by 11% but leave FY21-FY22 earnings estimates unchanged for now. With the re-implementation of the conditional-MCO in selected areas in Malaysia, we caution that sales volume recovery could be stifled in 4Q20. Moreover, rampant illicit share and ongoing consumer down-trading to the VFM category may also hinder any meaningful growth in the legal cigarette market and continue to suppress BAT’s margins going forward. Separately, BAT’s restructuring exercise has been fully completed in 3Q20.

Source: Maybank Research - 5 Nov 2020