This article first appeared in The Edge Financial Daily on November 4, 2019
British American Tobacco (Malaysia) Bhd
(Nov 1, RM18.50)
Downgrade to hold with a lower target price (TP) of RM19.20: Core net profit fell 30% year-on-year (y-o-y) to RM248 million for the first nine months of financial year 2019 (9MFY19), as British American Tobacco (Malaysia) Bhd’s (BAT) volume sales declined 13% y-o-y (industry volumes -11% y-o-y) while gross margins progressively compressed due to down trading towards value-for-money cigarettes. Although illicit cigarette volumes also fell y-o-y in tandem with the overall market contraction, their market share rose to an all-time high of 65% in the third quarter of 2019 (3Q19) — reversing the cutback seen in the first six months of 2019, partially due to the significant quarter-on-quarter drop in vape sales. Overall, the results disappointed the street and us, accounting for 66% and 68% of full-year estimates respectively due to the worse-than-expected volume decline.
As the increase in enforcement activities by authorities against the illicit trade failed to yield significant results, while the overhang of prohibited vape products’ prevalence remains unresolved, the management has turned to cost-cutting measures in lieu of growth-based endeavours. These include an internal reorganisation affecting 20% of its existing staff from 4Q19, in addition to a moderated advertising and promotional budget going forward. Despite the introduction of its heat-not-burn product line (Glo) which is priced competitively and yet offers higher margins due to much lower excise duty charges on its Neo heat sticks, we do not expect the ensuing profit contribution to be enough to make up for declining sales of its traditional cigarettes over the near term.
We cut our FY19-21 earnings per share estimates by 10-18%, reflecting our less optimistic stance on volume sales recovery in view of the unyielding illicit cigarettes and vape situation, while banking on cost-cutting to prop up profits going forward. Post-revision, we downgrade BAT to a “hold” (from “buy”) with a lower dividend discount model-derived TP of RM19.20 (from RM27.80). Yields of about 6% do not present enough appeal due to the elevated earnings uncertainty, in our view. The upside risks are better-than-expected enforcement outcomes, reversal of excise duty hikes and abating competition from alternative products. Meanwhile, the downside risks are weaker-than-expected enforcement outcomes, resumption of excise duty hikes and heightened competition from alternative products. — Affin Hwang Capital, Nov 1