This article first appeared in The Edge Financial Daily, on May 11, 2016.

British American Tobacco (M) Bhd
(May 10, RM46.94)
Upgrade to add with an unchanged target price (TP) of RM 51.00: British American Tobacco (M) Bhd’s (BAT) share price has tumbled 13.4% since its first quarter of financial year 2016 (1QFY16) results were announced. We believe the sell-off was due to concerns over its declining sales volume, which led to a 27.9% year-on-year (y-o- y) earnings decline in 1QFY16.

To recap, monthly legal industry volumes declined by 29.7%, while BAT recorded a steeper volume drop of 34.1%. Furthermore, contraband cigarette volumes spiked to an all-time high of 45.6% in March 2016 as customers turn to cheaper alternatives.

At current prices, the stock is worth a revisit, in our view, given its compelling dividend yields of 5.5% to 5.9% for FY2016 to FY2018 forward (FY16 to FY18F), sales volume showing a month-on-mocompany’s unexciting earnings outlook due to uncertainties surrounding its restructuring plans.

We also see a limited downside risk to the share price, thanks to the support from its dividend yields. Furthermore, we believe that the market has yet to price in positives from its restructuring plans.

To recap, BAT will cease all manufacturing activities by the second half of 2017, and focus solely on local retail activities using outsourced products from selected regional BAT factories. We note that management is confident that overall margins can increase with its restructuring plans. This is after taking into account that it is no longer sustainable to manufacture locally, given its underutilised capacity and the yearly hikes in duties.

We also do not discount the group potentially declaring a special dividend from the proceeds from its land sale. Based on our back-of-the-envelope calculations, the group’s 504,885 sq ft land should be worth an estimated RM227.2 million to RM252.4 million, based on RM450 to RM500 per sq ft. This could translate into a special dividend of 71 sen to 78 sen per share, based conservatively on 80% of the proceeds returned to shareholders.  

We make no changes to our earnings estimates and dividend discount model-based TP of RM51. In our view, the pullback in share price is overdone at this juncture and positives have emerged in the stock at these levels.

We expect investors to begin seeing value in the group’s restructuring plans, while taking into account the reduced risk of excise duty hikes and expected recovery in sales volume. — CIMB Research, May 10