KEY INVESTMENT HIGHLIGHTS

• 4QFY19 earnings came in at RM97.7m, in line with our expectation

• Sales volume declined due to the persistent high level of illegal cigarettes consumption

• Nevertheless, BAT’s overall market share within the legal market remain stable

• Current valuation is not reflective of the organisation’s strength and fundamentals

• Maintain BUY with a revised TP of RM16.00

Earnings met expectation. British American Tobacco (M) Bhd’s (BAT) 4QFY19 normalised earnings came in at RM97.7m. This brought its full year FY19 earnings to RM345.7m which met ours and consensus’ fullyear FY19 earnings estimates at 100.7% and 103.6% respectively. Comparing against 4QFY18, 4QFY19 revenue dipped by -14.0%yoy resulting from a lower sales volume. However, normalised earnings staged an encouraging +20.1%yoy growth driven by aggressive cost cutting measures e.g. reduction in headcount.

Continue to be impacted by legal market contraction. The dip in BAT’s 4QFY19 sales volume of -11.7%yoy was mainly attributed to the lower legal industry volume which contracted by a similar quantum of - 10.0%yoy. The illicit cigarettes volume share remains high at about 63.0%. Additionally, the rapid increase on unregulated vaping products will continue to impact the tobacco industry. Currently, unregulated vapour accounts for about 10.0% of total market share. The Ministry of Health (MoH) announced that a bill on the usage of tobacco, vape, electronic cigarettes and shisha is expected to be table in parliament next month. We opine that regulation on vaping will present an opportunity for a new revenue pool for the group.

Market share remain stable. BAT’s total market share year-to-date within the legal market declined marginally by -1.8ppt to 54.7% in 4QFY19 despite a significant contraction in the legal industry volume. Currently, Rothmans remains the fastest growing brand within the Value For Money (VFM) segment with a market share of 6.7% against last quarter’s of about 4.1%. This has enabled the group to achieve about 32.0% market share in the VFM segment which was line with our expectations. Meanwhile, Dunhill held a commendable market share of 35.5% in the premium segment (vs 37.5% in 4QFY18) despite the pressure from Value For Money (VFM) segment.

Declared 33sen dividend for 4QFY19. BAT declared a fourth and final dividend of 33sen per share for 4QFY19 (vs 4QFY18 of 47sen). Cumulatively, dividend declared for FY19 is of RM1.18 per share (vs FY18 of RM1.55). This brings its dividend payout ratio to 98.0% of earnings.

Impact to earnings. We maintain our forecasts as our estimates are still within expectation.

Target price. We revised our TP downward to RM16.00 (previously RM25.90) per share. Our valuation is derived from a dividend discount model valuation with a cost of equity of 8.5% (previously 7.0%) and a long term expected dividend growth rate of 0.5% (previously 1.0%). We update our cost of equity assumption as we take into account a higher required rate of return on equity and dividend growth rate given the insufficient efforts taken by the government to tackle the illicit cigarettes trade which contract the legal cigarettes market.

Maintain BUY. We opine that business environment will continue to remain challenging for BAT in the near term. Nonetheless, we are comforted by the group rationalisation effort and continuous investment to develop new product categories such as “Glo”. We also anticipate that the government consideration on regulating the vaping industry will bode well to the legal tobacco players. Following on this, the group will continue to work closely with the government on setting up a comprehensive and sustainable total regulatory and fiscal framework for the industry. Due to the recent decline in share price, we believe the risk-reward profile has become attractive as the stock offers an attractive dividend yield of +9.4%. Furthermore, the current valuation does not reflect the organisation’s strength and fundamentals. All factors considered, we maintain our BUY recommendation on the stock.

Source: MIDF Research - 21 Feb 2020