Review

• BAT’s 1QFY17 earnings came in below ours and consensus expectations at 16% of full-year forecasts. Excluding all exceptional items i.e. FX losses, derivatives gains and restructuring costs (RM2.1mn), BAT’s adjusted net profit declined by 23.2% QoQ to RM120.9mn. This was due to decline in Domestic and Duty Free volume, on the back of growth in illegal cigarettes post GST implementation in Apr-15 and excise duty hike in Nov-15 whereby cigarettes prices increased to an average of RM17.50/packet from RM13.00/packet in 2014.

• YoY, BAT’s revenue dropped due to 24.5% lower domestic sale and export volume. Meanwhile, operating expenses reduced by 18.1% YoY due to i) lower recharges from related entities, ii) overhead savings from the cessation of manufacturing activity, and iii) timing of spends. These have filtered down to the bottomline with core profit slipped by 31.2%.

• 1QFY17 revenue decreased by 8.3% QoQ to RM770.7mn due to decline in sale volume of 20%. The adjusted net profit declined by significant 23.2% due to higher taxation.

• In terms of market share, the group’s market share drop from 57.1% in Dec- 16 to 53.5%. In the premium segment, Dunhill’s market share declined by 1.3p.p to 37.3% year to date. Meanwhile, Aspirational premium brands recorded a growth of 12.1% mainly due to the performance of Peter Stuyvesant’s with a 7.7% share of market gaining 0.7p.p when compared to previous quarter.

• The board declared an interim dividend of 40sen for the quarter under review.

Impact

• We reduced our earnings by 30.9% and 31.0% for FY17 and FY18 respectively after reducing our domestic sales projections by 15.0% and 10.0% respectively. We have also changed our total industry volume growth assumption from 1% improvement to 10% decline for FY17 and FY18 due to the rise in market share of illicit cigarettes.

Outlook

• We view that illegal cigarettes trade will continue to be a cause for concern for the tobacco manufacturers in Malaysia, including BAT. Strict enforcement in curbing illicit trade is much needed than ever given that illegal cigarette market share has climbed to 57.1%. Meanwhile, the increase in excise duty which will lead to higher cigarette price may exacerbate the situation.

• Moving forward, BAT will source its cigarettes from Indonesia, Korea and Singapore. Majority of the volume will be imported from Indonesia where payments will be in USD

Valuation

• Hence, we downgrade our target price to RM52.08/share (previously RM54.22/share) based on DCF valuation with a discount rate of 6.3%. We maintain our Hold recommendation call and we expect no excise duty and cigarette price increase for this year.

Source: TA Research - 21 Apr 2017