This article first appeared in The Edge Financial Daily on December 5, 2019

British American Tobacco (Malaysia) Bhd
(Dec 4, RM15.62)
Maintain reduce with an unchanged target price (TP) of RM15.45: The Dec 2 to 8 edition of The Edge Malaysia weekly features a special report with a double-bill interview, one with Deputy Health Minister Dr Lee Boon Chye and another with Malaysian Vape Chamber of Commerce (MVCC) president Syed Azaudin Syed Ahmad and secretary-general Ridhwan Rosli. Each of the two articles making up the report focuses on the issues plaguing the tobacco industry, including: i) the government’s alleged “lack of empathy” with the existing players over their uphill battle to combat the illegal trade; and ii) the pros and cons of regulating vapouriser products and electronic cigarettes.

We deduce that there is little cohesion among the cabinet on how to tackle the illicit cigarette conundrum with a market share of 65% as of the end of the third quarter of 2019. While it is understandable that the ministry of health (MoH) stays taut with its mission to reduce the total number of smokers, Lee seems dismissive of the illicit trade, and leave it to the ministry of finance and the Royal Malaysian Customs Department to handle the matter. He has said that the MoH’s jurisdiction covers legal tobacco players only, while the illicit trade is beyond the ministry’s remit. We argue otherwise. The Control of Tobacco Product (Amendment) Regulations 2008’s Regulation 15c (3) states that health warning labels on cigarette packaging “shall not be obstructed visually or obscured by any device or any means” at points of sale for cigarettes. This means that retailers are also liable to adhere to the health warning displays. Thus, the MoH should have the power to penalise shop proprietors that carry bootleg cigarettes with no health warning labels.

Lee has begrudgingly admitted that a total ban on vapes would create enforcement problems, saying the MoH is hopeful that it can come to a decision on vaping regulation by 2020. If the ministry gives its green light, British American Tobacco (Malaysia) Bhd (BAT) can then enter the vaping market, which the MVCC estimates to be worth north of RM2 billion. BAT has estimated that vapes make up about 9% of the enlarged tobacco market in Malaysia, while legal cigarettes’ share stands at 25%.

BAT remains a “reduce” and our dividend discount model-based TP of RM15.45 stands pat. The group’s earnings have deteriorated to the point that it is reviewing its cost structure to remain profitable. One-off expenses of cost-rationalisation exercises leave its financial year 2019 (FY19) to FY21 dividend yields at risk. More earnings headwinds come from waning demand for cigarettes and possible higher expenses to market new products. — CGS-CIMB Research, Dec 3