British American Tobacco (Malaysia) Berhad (“BAT”) was formed in November 1999. It is a result of merger between Rothman of Pall Mall (Malaysia) and Malaysian Tobacco Company. Their principal business involves the importation and sale of cigarettes under two categories:

In the past, BAT manufactures its product locally in Malaysia. However, the challenging business environment has led to the company shut its factory in 2017. It later reopens a smaller size factory in Johor Bahru for maintaining its manufacturing license.

BAT was once a darling for all dividend investors. Its dividend payout were increasing every year. Share price tops at RM72.67 per share back in year 2014. So, what happened in the past?

I mentioned this in my recently launched book – Dividend Growth Investing – that BAT was undergoing a structural change. It was a value trap at that time. This is because of the one-sided regulations where excise duty was hiked significantly on legal cigarettes. There is less regulation to curb the illicit cigarettes. As a result, people are buying more from the black market as it is cheaper.

The market share for illicit cigarettes went up as high as 64.1% in 2020 according to Nielsen research. The growing trend of people using vapes also spells trouble for BAT. However, today I see signs of structural change again due to the following 3 Key Insights:

#1: INCREASING REGULATIONS TO CURB ILLEGAL MARKET

In the past, our government used to implement steep excise duties on legal tobacco products. From June 2013 to November 2015, the excise duty for cigarette has increased by approx. 71%. Less regulation was seen to curb the illegal tobacco market.

But there seems to be sign that the government are changing their direction. In their previous budget announcement for 2021, they propose freezing of import license for cigarettes. We already seen this move taking effect on the illegal cigarettes’ market share.

According to Nielsen’s May 2021 research, the illegal cigarette market share has been dropping from 64.1% to 57.9%. I think that this trend will continue but on a slower pace. This is because BAT’s management highlighted that these criminal syndicate are turning to small jetties across Malaysia coast to smuggle in cigarettes.

#2: BAT’S IMPROVING QUARTERLY RESULT

Nevertheless, BAT’s quarterly result is seen improving recently. The company has registered an increasing revenue for the past 3 quarters in year 2021. This was partly due to its VFM segment. In my opinion, this is the company’s next growth drivers. However, this segment has thinner margin than its premium segment.

#3: MORE EXCISE DUTY ON VAPES & E-CIGARETTES

In the Budget 2021, the government also imposes excise duty on e-cigarettes and vapes that are non-nicotine based. This seems to indicate that the government is legalising the vaping industry. The recent Budget 2022 added another taxation rule where excise duty on nicotine-based vapes and e-cigarettes will be introduced.

Interestingly, no excise duty hike was announced on cigarettes. Moving forward, I foresee more regulation and taxation on e-cigarettes and vapes since this is a growing industry.

According to the Malaysian Vape Chamber of Commerce (MVCC), vapes account for 42% share of the total tobacco market. While both the illegal and legal cigarettes account for 37% and 21% respectively as of Dec 2020.

As such, more regulation on vaping industry is good news for BAT and other major tobacco players in Malaysia. It will level the playing field for these tobacco players. Nevertheless, vapes still remains as the cheapest option compared to cigarettes. That’s the reason why BAT confirms that they will enter the Malaysia vape market once it is regulated.

According to UOB Kay Hian Research, BAT’s vapour products under Vuse brand are quite well-known. It has an average 45% market share across the United States, United Kingdom, Canada, France, and Germany. I think that BAT’s performance will be much better once it enters the vaping market in Malaysia.

MY INSIGHTS

So, is BAT still a value trap? Based on the above signs, it seems like BAT’s operating environment is slowly changing in their favor. In my opinion, BAT will be out of this value trap completely if it enters the local vaping market. For now, the illegal market still remains a concern to the company’s business performance.

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