This article first appeared in The Edge Financial Daily on September 13, 2018

British American Tobacco (Malaysia) Bhd
(Sept 12, RM34.46)
Maintain underperform with a higher target price (TP) of RM28.25: Physical checks detected a 50 sen price increase across British American Tobacco (Malaysia) Bhd’s (BAT) product portfolio, similar to most competing brands. While the rise was lower than anticipated, we are still negative as this will not alleviate the prevalent illicit market situation.

However, we raised our TP to RM28.25 from RM27.10 as we narrow the gap between product mixes in anticipation of less down-trading by consumers; hence, improving earnings.

In our Aug 27, 2018 sin sector update entitled “Another Tax Bummer”, we anticipated a maximum increase in prices of 10% across the product portfolio following the implementation of the new sales and services tax structure.

Following physical checks, we detected that a consistent 50 sen increase has been implemented. New prices are as follows; premium brands at RM17.50 (from RM17.00), aspirational premium brands at RM16.00 (from RM15.50) and value-for-money at RM12.50 (from RM12.00).

We continue to anticipate that illicit trade volumes could increase due to the huge price gap between legal and illegal product market prices.

Down-trading from premium to aspirational premium and value-for-money products could also be anticipated as consumers attempt to work around the issue of affordability.

As recently reported in the news media, the Malaysian International Chamber of Commerce and Industry (MICCI) called for a special multi-agency task force to be set up to tackle the issues of smuggling and illicit trades.

While we agree that more aggressive enforcement could be necessary to address the problem, we stay from any positive expectations at the moment as delivering results has proven to be a challenge as in past regimes.

With this update, we tweak our estimates to reflect a less narrow gap between the sales of premium and non-premium brands. We had earlier accounted for a much wider gap from the existing sales mix (2QFY18: premium brands account for around 75% of sales).

Nonetheless, we still maintain our passive stance on legal volume growth. This resulted in a 3.2% or 4.2% improvement in our FY18E/FY19E earnings estimates from our sector update revision.

Maintain “underperform” but with a higher TP of RM28.25 based on an unchanged 18.0 times FY19E price-to-eranings ration (-1.5SD three-year mean) on a revised EPS.

Dividend yield of 4.5% for both FY18E/FY19E may seem decent, but is likely to be dampened by potential capital downside.

Risks to our call include faster-than-expected recovery of legal market share, lesser-than-expected conversion towards less premium brands, and significant decrease in forex to improve cost of sales. — Kenanga Research, Sept 12