1HFY20 CNP of RM116.2m (-30% YoY) came in within our expectation. As the sales and distribution activities are expected to normalise after the spike of restocking activities in May post MCO disruptions, we believe the group is likely to remain challenged by dwindling industry volumes and poorer product mix ahead. Maintain MARKET PERFORM with unchanged TP of RM10.05, as the foresaid demerits are cushioned by an attractive dividend yield of c.7%.

Within our expectation. 1HFY20 core net profit (CNP) of RM 116.2m (after accounting for RM10.8m restructuring expenses) came in within our expectation at 53% but missed consensus at 44%. The declared dividend of 18.0 sen (YTD: 35.0 sen) is also deemed to be within expectation.

Continual decline observed YoY, 1HFY20 revenue continued to record a decline of 19%, largely dragged by: (i) persistent shrinkage in legal market volume (-6%) and BAT product volume (-18%) due to the shift in demand towards illegal cigarettes and vaping products, coupled with (ii) weaker duty-free sales which were severely impacted by fall in passenger traffic during lockdowns. Consequently, CNP fell by 30%, as core EBIT margin (-1.9ppt) remains pressured by continuous down trading to lower-margin value-for-money (VFM) product (i.e. Rothmans). The thinner margin was slightly cushioned by the group’s cost rationalisation exercise, which saw operating expenses falling 31% YoY.

QoQ, 2QFY20 revenue and CNP rose 14% and 11%, respectively, as the negative impact from supply disruption during MCO in April was offset by the ramp up of sales and distribution activities after the relaxation of movement restrictions in May. Notably, both industry and BAT volume recorded improvements of 10% and 15% respectively, similarly due to (i) spike in restocking activities post-MCO disruptions, coupled with (ii) the shift in retail landscape to convenience stores from restaurants and cafes (which were more likely to supply illicit tobacco) as the latter were mostly closed/ not available for dine-in during MCO and CMCO.

Illicit trades continue to take the centre stage. With sales and distribution activities expected to normalise after the spike in May, we believe the group is likely to remain challenged by dwindling industry volume and poorer product mix. Weaker purchasing power caused by a disrupted economy may also very well exacerbate the issue of affordability, diverting smokers to illicit cigarettes and vaping products. Therefore, we maintain our view that any meaningful recovery would only materialise with a sustained clampdown on illegal cigarettes (which takes up c. 69% of market share). On a side note, the group has recently launched the new “KYO” brand which is priced slightly lower than Rothmans in the VFM segment, with hopes to capture a greater share of the down-trading activities in the legal market.

Post-results, we made no changes to our earnings forecast.

Maintain MARKET PERFORM with TP of RM10.05 based on an unchanged valuation of FY21E PER of 13.0x (closely in-line with - 1.5SD over the 3-year mean). Despite the stock offering a fair dividend yield of c.7%, the lack of visible improvements in the operating environment remains a threat. Risks to our call include: (i) lower/higher-than-expected operating expenses and (ii) weaker/stronger-than-expected product volume

Source: Kenanga Research - 24 Jul 2020