KEY INVESTMENT HIGHLIGHTS

• 1QFY20 earnings below expectations

• Sales volume contracted by 21.0%yoy and 24.0%qoq

• Earnings revised by -16.7% for FY20E and -8.6% for FY21F

• Maintain BUY with a revised TP of RM15.70

1QFY20 earnings below expectations. British American Tobacco (M) Bhd’s (BAT) 1QFY20 normalised earnings came in at RM55.0m. This accounts for 15.8% of ours’ and 17.4% of consensus full year estimates. The lower than expected core net profit can be attributed to compressed profit margins due to lower sales volume particularly from the duty-free segment. An interim dividend of 17.0sen was announced, which is also below our full year expectation. This implies a payout ratio of 95.5%, which is lower than the 98.0% payout ratio in FY19.

Sales volume contracted by 21.0%yoy and 24.0%qoq.

Normalised net profit fell -69.2%yoy to RM55.0m in tandem with revenue that decline -61.9%yoy to RM481.2m. We have excluded a oneoff restructuring cost amounting to RM4.2m from our normalised PAT. The cigarette industry continues to be plagued by the illicit products. Moreover, its duty-free segment, which comprises 4% of topline, was adversely impacted by regional and international travel restrictions due to Covid-19. BAT’s portfolio which is skewed towards the premium segment experienced steeper contraction of 21.0% in sales volume compared to the legal industry volume of 11.0%yoy during the period. Illicit cigarette and nicotine vaping product sales growth continues to challenge the legal tobacco market despite increased enforcement actions from Government agencies. The illicit cigarettes volume share remains high at about 63.0% but the figure has been stable and unchanged compared to 4QFY19. On a more positive note, the cost restructuring programme that the group has taken in 2019 has resulted in lower operating expenses (19.4%yoy toRM13.0m). Nonetheless, the benefits from this exercise is offset by lower revenue, leading to a decline in profitability.

Earnings revised by -16.7% for FY20E and -8.6% for FY21F. We are turning more cautious with the near-term sales outlook for BAT as we take into consideration of the impact by Covid-19. Other than lower duty-free sales, we also expect some disrupted patterns in sales volume during the movement control order period.

Maintain BUY with a revised TP of RM15.70 from RM16.00 previously. Our valuation is derived from a dividend discount model valuation with an unchanged cost of equity of 8.5% and a long-term expected dividend growth rate of 0.5%. While we think that industry headwinds may persist in the foreseeable future, management’s restructuring exercises that had been implemented will show positive results when the business environment improves. Dividend yield is still deemed attractive, estimated at 7.5%.

Source: MIDF Research - 22 May 2020