British American Tobacco (BAT)’s 1QFY13 earnings of MYR204.2m (+5% y-o-y) were within expectations. Revenue and bottomline grew despite continued weakness in domestic volumes as stronger exports and lower operating expenses lifted profitability. We are raising our FV to MYR61.07 on higher earnings expectations but remain NEUTRAL on the stock on its rich valuations and in anticipation of heightened regulatory risks post-GE13 for the tobacco industry.

- Within expectations. BAT posted 1QFY13 revenue of MYR1,095.7m (+5.1% y-o-y, +0.2% q-o-q) as significant growth in export subcontract manufacturing revenue (+235.0% y-o-y) more than offset the weakness in domestic sales (-4.1% y-o-y). Although gross profit declined to MYR355.0m (-3.4% y-o-y, -4.6% q-o-q), its sharply lower operating expenses due to the later timing of marketing expenditure and the absence of a MYR8m impairment led to stronger earnings of MYR204.2m (+5.0% y-o-y, +3.8% q-o-q) for the quarter. The cigarette manufacturer’s 1QFY13 profit reflects 26.6% and 24.9% of our and consensus estimates.

- Weaker volumes. BAT’s 1QFY13 domestic sales volume fell to 2.04bn cigarette sticks (-7.0% y-o-y, -2.9% q-o-q) following the Government’s decision to raise transfer prices used to determine ad valorem taxes, which led to a MYR0.20 per pack increase in selling prices. The company’s volume shrinkage was, however, sharper than that of its peers (Big3 volume: -4.8% y-o-y), likely due to continued growth for Phillip Morris International’s Marlboro Ice Blast. The Nielsen Co reports suggest that BAT’s market share grew by 0.8ppt to 61.5% compared to FY12, underpinned by a 1.1ppt market share gain for Dunhill.

- Raising FV but maintaining NEUTRAL. We are lifting our FY13 and FY14 earnings forecasts by 4.1% and 1.1% respectively on lower marketing expenditure expectations, raising our FV to MYR61.07, based on our FCFF model (WACC: 5.5%, terminal growth: 1.0%). We also increase our dividend payout assumption to 97.5% from 95.0%
previously following the higher-than-expected MYR0.68 per share interim dividend. We see heightened regulatory risks post-general elections for the industry, with a likely tobacco excise duty hike in Budget 2014.

Source: RHB