BAT is set to outlast the challenging but temporary twin headwinds with the anticipated more subdued future excise duty hikes and its leaner opex. Maintain NEUTRAL with a revised DCF-based TP of MYR55.60 (from MYR54.50, 1% downside). We expect FY16F-18F earnings to remain flat, which are commendable given the circumstances. The estimated dividend yield of 5.5% should be supportive of its share price.
Surviving twin headwinds. We anticipate FY16F-18F earnings to remain flat, underpinned by twin headwinds: i) the higher cigarette excise duty hike, and ii) worst recorded consumer sentiment. This is alleviated by our anticipation of a sustained leaner opex structure and future excise duty hikes to revert closer back to 3 sen/stick, as opposed to the most recent hike of 12 sen/stick (Figure 5). Barring a similar quantum hike in Nov 2015, cigarette excise duty hikes are typically earnings-accretive, as British American Tobacco (BAT) has priced in a sufficient buffer for its cigarettes. Against the backdrop of rather inelastic demand (0.5) for cigarettes, this should result in earnings more than offsettingthe fall in volume.
Other highlights. Minimum wage hike is a non-factor whilst BAT is naturally hedged against the USD. Factoring in our leaner opex assumption, we raise our FY17F earnings by 2%. Risks to our call include increased proliferation of illicit cigarettes and a sluggish recovery in cigarette volume sales.
Maintain NEUTRAL. We believe that current valuation of 17.9x FY16F P/E (at -1SD of its 5-year historical mean) fairly reflects BAT’s flat earnings growth. As we roll over our valuations to FY16F, we adjust our DCF-based TP to MYR55.60 (from MYR54.50). The estimated dividend yield of 5.5% for FY16-18 should be supportive of its share price.
Briefing Highlights Leaner opex structure a boon. The decline in FY15 opex (-8.7%) outpaced a drop in net turnover (-4.1%), attributing to: i) discontinuation of cigarette rations to its employees, ii) lower overhead costs, and iii) deferred marketing activities. Going forward, we believe existing margins may be sustainable to a certain extent, underpinned by BAT’s continuedcost management and lower headcount at its production facility.
Dividend payout would not exceed 100%. Management reiterated that the company would not employ capital management to sustain its absolute dollar payout in the event that earnings do not reach previous levels. Still, we are confident of BAT’s proven operational execution, which had resulted in earnings contracting less than 2% over the past 10 years, with the exception of FY09 ( -8%).
Natural hedge against the USD. Management stated that its contract manufacturing sales naturally hedge against its USD-led input costs. However, we note that the continued contract export volume could result in negative exposure to an appreciating USD, albeit minimal. Going forward, contract manufacturing sales may continue to decline with lower demand, primarily from Australia, South Korea, Philippines and Taiwan.
