British American Tobacco (M) Bhd (BAT)
(Oct 17, RM67.12)
Maintain “reduce” with a target price (TP) of RM58.10: BAT’s nine months of financial year 2014 (9MFY14) net profit came in at 78.3% of our full-year forecast and 79% of consensus. We deem the results to be in line as we expect its net profit growth to normalise in the fourth quarter (4Q), given that BAT has raised its selling prices at end-September last year. Despite continual local and export sales volume decline, 9M revenue and net profit increased, thanks to higher selling prices. Although domestic and contract manufacturing volume dropped by 6.2% and 12.6% year-on-year (y-o-y) respectively; the higher selling prices (up by RM1.50 per pack) were more than sufficient to offset the drop in sales volume.
While contract manufacturing remained weak, the contraction was less in 9MFY14 versus first half of financial year 2014 (1HFY14). Domestic volume dropped by a larger extent in 9MFY14 versus 1HFY14, due to the large 7.3% decline in 3QFY14 itself. In 3Q, domestic volume was impacted by the lower consumption during the Ramadan month in July and loss of market share due to the disparity between its selling prices and those of its competitors when it raised its prices for two weeks in September.
Given that Pall Mall accounts for the bulk of its sales volume, the brand was impacted the most during the two weeks of higher selling prices. Despite the higher operating expenses y-o-y due to the increase in investment in brand activation programmes and trade retail contracts, earnings before interest and taxation margin improved 1.6% y-o-y to 26.9% in 9MFY14. The repayment of medium term note in August also resulted in lower interest expense.
We maintain our earnings per share (EPS) forecasts and discounted cash flow -based TP. We also keep our “reduce” call as we think that legal cigarette volume will continue to be under pressure. More importantly, BAT’s leadership position in dictating future cigarette price hikes could be eroded following the reluctance of its competitors to follow suit when it increased its selling prices recently. BAT declared a second interim dividend per share of 78 sen, in line with our forecast. We prefer Gudang Garam. — CIMB Research, Oct 17
This article first appeared in The Edge Financial Daily, on October 20, 2014.