INVESTMENT HIGHLIGHTS

• Resilient 4QFY18 normalised earnings of RM116.4m, despite illicit cigarettes market stand at all time high of 63%

• FY18 normalised earnings of RM433.6m came in within expectations

• Declared a 47.0sen fourth interim dividend, leading to FY18 cumulative dividend of 155sen

• Maintain BUY with a revised TP of RM39.50 per share

Cumulative FY18 earnings within expectations. British American Tobacco (M) Bhd’s (BAT) 4QFY18 normalised net profit - after stripping out one-off GST benefit and refund on tax stamps and 2017 provision for impairment of prepaid excise duties; came in at RM81.4m. This lead to FY18 normalised earnings of RM433.6m, which is within ours and consensus’ full-year FY18 earnings estimates at 99% and 97% respectively. Comparing against 4QFY17, revenue grew by +12.5%yoy to RM770.6m whilst the respective normalised earnings grew marginally by <1.0% on a year-over-year basis. On a quarterly sequential basis, revenue staged an encouraging improvement of +4.8%yoy despite the contraction in earnings. Volume sold also improved by +2.2% in the fourth quarter largely due to seasonality and speculation prior to pricing.

Illicit cigarettes market remains stagnant at 64%. The dip in BAT’s FY18 overall revenue and, thus, earnings year-over-year was mainly attributable to the lower domestic and duty-free volumes which slumped by -5.8%yoy. The lower domestic volume was mainly impacted by the legal market volume which contracted by -3.5%yoy in comparison to 4QFY17. Additionally, the illicit cigarettes volume share remains stagnant at a record high of 64% since 1QFY18 which consists of smuggled cigarettes at 60% and quasi legal cigarettes with fake tax stamps at 4%. This, in return, has impacted the group’s volume, translating to a decline by -4.6%yoy in terms of the group’s overall volume sold.

Declared 47sen dividend for 4QFY18. BAT declared a fourth interim dividend of 47sen per share for 4QFY18. This is as opposed to 43sen declared during the same period last year. YTD dividend declared for FY18 of 155sen is within our dividend forecast of 149sen for the year which represents a full-year payout ratio of 94%. As such, we are maintaining our dividend forecasts at this juncture.

Earnings estimates maintained. We are maintaining our F19F earnings forecasts at this juncture. That said, we have factored in conservative assumptions in our earnings forecasts previously such as: (i) gradual recovery in sales due to high illicit cigarette trade; (ii) continued weak consumer spending power as well as; (iii) growth in lower price segment (VFM) within the legal market.

Maintain BUY. We are maintaining our BUY recommendation on BAT with a revised target price of RM39.50

(previously RM37.70) as we roll forward our valuation base year to FY20. Our valuation is derived from a dividend discount model valuation with a cost of equity of 6.5% and a long term expected dividend growth rate of 1.25%. We opine that while business environment will continue to remain challenging for BAT. However, we are comforted by the fact that BAT’s VFM brand Rothmans in 4Q17 remains the fastest growing brand which we opine will assist in sustaining its position as a market leader in the legal cigarettes’ domain. Additionally, the revenue and volume contraction has narrowed to low single digit from low double digits earlier this year and previous FY. This narrowing contraction which is mainly attributable to BAT’s ongoing cost rationalisation initiatives has translated to the recovery in BAT’s earnings and profit margin over the past few quarters. We understand from the Management that, this will be an ongoing process to cushion the effect of the decline in legal cigarette volume. As the share price of BAT has taken a beating last year due to the announcement of an increase in tobacco-related items tax and price, we opine that all the negatives have been priced; share price has bottomed out and; current price presents a good opportunity for accumulation of the stock. Aside from the recovery in earnings, its dividend yield remains attractive at 4.9% FY20F.

Source: MIDF Research - 22 Feb 2019