This article first appeared in The Edge Malaysia Weekly on February 28, 2022 - March 6, 2022

UNCERTAINTIES surrounding a potential new law to prohibit smoking and the sale of tobacco products to anyone born after 2005, in a move dubbed the “generational endgame”, may continue to weigh on British American Tobacco (Malaysia) Bhd (BAT Malaysia) in the short term, say analysts.

Its share price has fallen 6% since Health Minister Khairy Jamaluddin announced on Feb 17 that the government was looking to implement this law in Malaysia. The stock closed at RM11.82 last Wednesday, giving the company a market capitalisation of RM3.37 billion.

CGS-CIMB Research analyst Kamarul Anwar Kamaruddin says if the proposed law is passed, it will prevent BAT Malaysia from replenishing its customer base. He expects the black market for tobacco products to continue to thrive in such a scenario.

“The 1920s alcohol prohibition in the US exemplified how an outright ban of vices eventually led to the proliferation of such products on the black market, which created another set of social issues and crimes. In Malaysia, raising the excise duty on cigarettes has only perpetuated the black market for tobacco and vape,” he says in a Feb 16 report.

“In our view, smoking is not just a health issue but a socioeconomic one as well. Smoking is more prevalent among low-income earners the world over, and in Malaysia, over 74% of smokers come from households earning below the 2016 national household median, according to the findings of the National Health and Morbidity Survey 2015.”

Hong Leong Investment Bank Research (HLIB Research) analyst Sophie Chua Siu Li agrees that the potential generational ban on smoking would be detrimental to BAT Malaysia, considering that it would result in a gradual shrinking of its customer base. She opines that overregulation will likely fuel the sales of illicit cigarettes as affected consumers will turn to the black market.

“Should a generational ban on vaping be implemented, it would be counterintuitive in nature as vaping is a less harmful alternative available to the smokers. While this is not expected to be implemented in the short term, we think the gradual shrinking of its customer base would be detrimental to BAT Malaysia over the longer term,” she says in a Feb 17 note.

Both CGS-CIMB Research and HLIB Research are keeping their forecasts for FY2022 and FY2023 for now, but note that the idea of prohibiting future generations from vaping could stymie BAT Malaysia’s upcoming vape gambit.

“Already, this supposed catalyst has been tempered by the high excise duties for vape liquids and gels proposed by the finance ministry. The planned regulation brings risk to BAT Malaysia’s longer-term future earnings prospects, cash flows and dividend payouts because it could erode its customer base as time goes by,” says Kamarul Anwar.

BAT Malaysia, which carries cigarette brands such as Dunhill, Kent, Peter Stuyvesant, Pall Mall and Rothmans, is the country’s only public-listed tobacco company. JT International Bhd went private in June 2014, when it was purchased by its controlling shareholder, Japan Tobacco Inc.

Bloomberg data shows that of the 16 analysts covering BAT Malaysia, six have a “buy” rating, 12 a “hold” call and two recommend a “sell”. The consensus target price is RM13.56, representing an upside of 15% from last Wednesday’s closing price of RM11.82. The stock is currently trading at a one-year forward price-earnings ratio of 12.11 times. Based on the consensus estimate dividend per share of 96 sen for the financial year ending Dec 31, 2022 (FY2022), the counter currently offers a yield of 8.12%.

BAT Malaysia ended FY2021 on a high note, with an impressive net profit growth of 17.8% year on year (y-o-y) to RM284.86 million — its first since 2015, and volume growth for the first time since 2002. Revenue rose 14% to RM2.64 billion in FY2021 from RM2.32 billion in FY2020.

Maybank Investment Bank Research analyst Jade Tam says BAT Malaysia’s management shared that its volume grew 5% y-o-y in FY2021, mainly due to new market strategies through online and telesales, instead of relying solely on exclusive distributors to push their products, and the clawback of legal volumes from tighter transshipment regulations from January 2021.

She expects FY2022 volume growth to remain positive alongside the reopening of the economy post-pandemic. “Ramp-up in government enforcement in key areas will also see more legal volumes return to the industry,” she adds.

To date, Philip Morris (Malaysia) Sdn Bhd is the only tobacco company to have introduced a reduced-risk product (RRP) — IQOS — in Malaysia, which it launched in 2018. Both BAT Malaysia and JT International Bhd have adopted a wait-and-see approach until there is an appropriate regulatory framework for nicotine vaping.

HLIB Research’s Chua notes that BAT Malaysia made investments to improve its vapour readiness in 4QFY2021, to ensure that the group stands ready to introduce its own line of nicotine vaping products, under its Vuse brand, to the market once vaping products are legalised.

“We highlight that it is still difficult to ascertain if the introduction of Vuse will be margin accretive or dilutive at this point, as it will very much depend on the regulated pricing of the product. However, given the initial marketing and promotional spend to encourage switching to Vuse, we are of the view that the new line of vaping products is unlikely to be a significant contributor to the company’s bottom line,” she writes.

UOB Kay Hian Malaysia analyst Philip Wong believes that the earnings impact from the proposed legislation should be more than offset by the legalisation of the currently untapped vape segment. He points out that nicotine vaping is estimated to account for an 11% share of the overall tobacco market in Malaysia and about 40% of the traditional legal cigarette industry.

“Therefore, the legalisation of the lucrative and sizeable segment is a net positive despite some cannibalisation and a gradual phasing out of smoking through a potential generational endgame as mooted by the health minister,” he writes in a Jan 21 report.

According to Wong, the country’s largest tobacco company is expected to gain a significant foothold in the nicotine vaping segment once it is legalised in Malaysia, given its proven market leadership in key established markets. Currently, Vuse has an average market share of 45% in the vaping category across the US, the UK, Canada, France and Germany.

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