FY19 core net profit of RM361.1m exceeded expectations, on greater volume growth and better cost savings. While the group remains challenged by the obstinate illegal trade issue, value may have emerged from the recent sharp sell-down as (i) the stock is now trading below its 10-year low, and (ii) its appealing yield of c.9% which could offer some form of defence under the current market uncertainties. Maintain OUTPERFORM with higher TP of RM16.70 (from RM16.00) following an earnings bump.

Positive surprise. FY19 core net profit (CNP) of RM361.1m (after accounting for RM15.4m one-off restructuring expenses) came in above expectations at 108% of both ours and consensus’. We believe the positive deviation is underpinned by better-than-expected product volume growth as well as stronger-than-expected cost savings observed in the 4Q. The declared fourth interim dividend of 33.0 sen (full-year pay-out: 118.0 sen), also came above our forecast of 113.0 sen, which implies a pay-out ratio of 97.5%.

A weaker year overall... YoY, FY19 CNP fell 23%, largely dampened by: (i) weaker revenue (-11%) no thanks to the continual shrink in legal market volume (-10%) due to affordability issues and shift in demand towards illegal vaping products, coupled with (ii) thinner EBIT margin (- 3.4ppt) on poorer product mix as well as the absence of GST removal perks and tax stamp refunds. For the individual quarter, 4QFY19 CNP of RM113.1m slid 3%, as lower revenue (-14%) was partially mitigated by the group’s effective cost rationalisation efforts through an internal reorganisation, which kept EBIT margin stable at c.21%.

…but with QoQ improvement. 4QFY19 revenue rose 13% sequentially, boosted by greater product volume (+14%) following successful marketing activations for its Dunhill and Rothmans brands. On top of that, the group’s efforts to rationalise its cost base pumped EBIT margin up by 1.6ppt, consequently leading to a 36% growth in CNP.

Cloudy with a chance of sun? The group has managed to deliver a commendable QoQ improvement after several quarters of continual disappointments, mainly boosted by its product volume growth coupled with effective cost rationalisation exercises. Still, we remain cautious on its outlook, stemming from the unfavourable operating environment with illegal cigarettes taking up c.63% of the entire market share. That said, any meaningful improvement in the group’s fundamentals would only come from a sustained curb on illegal cigarettes. On the flip-side, we do not expect meaningful contribution from the group’s newly rolled-out “heat-not-burn” products (Glo and refillable Neo sticks) with an expected contribution of < 10% of the group’s sales in FY20.

Maintain OUTPERFORM with a higher TP of RM16.70 (from RM16.00). While we leave an unchanged valuation of 14.0x PER (closely in-line with the stock’s -1.5S.D. over its 3-year mean), we pumped our FY20E forecast upwards by 4% on account of lower operating expenses. Despite its cloudy outlook, we believe that value has emerged as the recent sharp sell-down in the stock may be overdone, with (i) the stock now trading at a compelling 11.0x PER which fell below its 10-year historical low, and (ii) an attractive dividend yield of c.9%, which could offer some form of defence under the current market environment.

Risks to our call include: (i) higher-than-expected operating expenses and (ii) weaker-than-expected product volume

Source: Kenanga Research - 21 Feb 2020