Review

• BAT’s 9MFY19 adjusted net profit of RM252.0mn (-20.9% YoY) was below expectation at only 65% and 67% of our and consensus full-year estimates, respectively. The negative variation was due to further deterioration in sales arising from prevalent illicit cigarette trade alongside illegal vaping, overshadowing the impact from downward normalisation of operating expenses in 3QFY19.

• The board declared a third interim dividend of 29.0sen/share (vs. 40.0sen/share in 3QFY18) bringing the YTD DPS to 85.0sen/share (vs. 108.0sen/share during 9MFY18).

• 9MFY19 revenue declined 10.0% YoY to RM1.85bn (meanwhile, excluding the SST impact, the adjusted revenue would have declined by 12.7% YoY to RM1.74bn) owing to reduction in BAT’s market volume to 2.46bn sticks (-12.9% YoY). As a result of softer sales, the adjusted EBIT declined by 22.0% YoY to RM343.7mn.

• Sequentially, revenue declined by 8.8% QoQ due to i) contraction in legal cigarette market and ii) structural downtrading from premium and aspirational premium segment. Correspondingly, 3QFY19 BAT’s volume fell by 8.6% QoQ, losing some market share from the legal market (-0.4%- pts to 54.6%) which experienced -3.9% QoQ decline in volume. Despite registering weaker sales, 3QFY19 adjusted EBIT increased by 5.6% QoQ to RM114.7mn as BAT took aggressive measures in rationalising its cost base.

Impact

• Given the dismal structural environment which we now deem unlikely to improve in the near term, we cut our FY19-21earnings forecast by 16- 31%. The change is a result of us cutting our BAT’s cigarette volume assumption by 10-20% to 3.2/3.1/3.0bn sticks from 3.6/3.6/3.7bn sticks on the premise of shrinking legal cigarette size.

Outlook

• Management shared that legal market volumes of cigarettes are further challenged by affordability issue, where legal cigarettes now only represents one-quarter of the total Malaysian market (total Malaysian market defined to include cigarettes, vapes and tobacco heating products). The level of illicit cigarettes has increased to a record level of 65% in 3QFY19 while vapes are estimated to make up 9% of the total Malaysian market.

• With regards to enforcement against illicit cigarettes, Malaysian customs and police forces are believed to have confiscated c.0.5bn sticks of illegal cigarettes (+13% YoY) during Jan-Sep 2019. The run rate of raids appears to be significantly lower than government’s initial hope of recouping RM1.0bn in tax losses (translate as sale of 2.5bn sticks) through clamping down smuggled and fraudulent activities.

• We understand that BAT has began marketing its THP products (the device – glo and the stick –NeoStik) in October with more activation activities to be carried out in the coming months. Pricing of glo is set at RM150.00 while NeoStik is set at RM14.00 for a pack of 20s. We think THP may not necessarily be earnings accretive in its infancy stage and such product segment may require fairly long gestation period.

Valuation

• Corresponding to the earnings downgrade, we downgrade BAT to Hold call with lower target price of RM19.20/share based on DCF valuation (WACC: 7.1%; g: 3.0%). We are turning conservative on BAT’s performance in the years to come thus projecting erosion in earnings that would result in lower forward FY20 dividend yield of 5.2%.

Source: TA Research - 1 Nov 2019