BAT : NEUTRAL at RM43.98, TP of RM42.00

British American Tobacco (M) Bhd
(July 23, RM43.86)
Maintain neutral at RM43.98 with target price of RM42: Our target price is pegged at RM42 based on WACC of 7.5%. We maintain our neutral recommendation. BAT’s continuously high dividend payout in excess of 90% and dividend yields of about 6% per year remain attractive. No changes to our dividend per share (DPS) estimates for FY2010f and FY2011f. Key concerns include: (i) expectation of higher excise duty in the upcoming Budget 2011; and (ii) enforcement will remain a challenge from higher illicit trade.

Annualised 2QFY2010 net profit came within our and consensus expectation which accounted for 50% and 52% respectively of FY2010. In 1HFY2010, both profit before tax (PBT) and net profit eroded by 6.4% year-on-year (y-o-y) and 7.2% y-o-y due to: (i) lower sales volumes; (ii) higher costs of Dunhill resealable Reloc packs; (iii) timing of marketing and overhead expenditure; (iv) marginally higher finance cost; and (v) higher effective tax rate. However, these additional costs were partially offset by BAT’s productivity and cost management initiatives. As expected, BAT declared its first interim dividend of 113 sen per share, tax exempt under the single-tier tax system. The payment date has been fixed on Aug 20.

2QFY2010 revenue rose marginally by 1.7% y-o-y but fell by 2.4% quarter-on-quarter (q-o-q) due to higher excise led pricing. But the negative impact from higher excise led pricing was partially offset by the ban on less than 20 sticks per pack. Also contributing to the q-o-q decline was the marginal decline in sales volume by 0.1% y-o-y. To recap, in late September 2009, tobacco excise duties were raised by 1 sen per stick, lifting tobacco duty to 19 sen per stick. Subsequently, tobacco manufacturers raised cigarette selling prices by 1.5 sen per stick to pass on the cost to consumers. Nonetheless, their earnings before interest and tax (Ebit) margin slid to 26% from 27.6% in 2QFY2009 as a result of higher operating costs (+0.3% y-o-y).

The total industry volume (TIV) continued to remain flattish and BAT’s sales volume contracted marginally by 0.1% y-o-y to 2.22 billion sticks in 2QFY2010. It implies that the post-excise hike has forced smokers to switch from the premium segment to the value for money (VFM) segment. Also, the illicit trade for the third wave (Oct-Dec 2009) was at 37.1 %, a slight reduction from 38.7% previously, indicating the illicit trade could be either stabilising or dwindling in view of the more stringent enforcement by the authorities. According to management, the latest illicit trade rate will be released in mid-August and it should be lower than the 37.5% in 2009.

As at year-to-date May, BAT’s portfolio of brands performed commendably, garnering 60.3% of the market share, up 0.3 percentage point (pp) against the same period last year (SPLY). The positive growth was due to stronger performance from BAT’s global-drive brands with Dunhill raking the highest market share of 44.8%. The company’s Kent brand also improved by 2.8% (+0.1 pp against SPLY), while the VFM brand of Pall Mall performed well, garnering a market share of 7.9% (+0.4 pp against SPLY), benefitting from the impact of smokers switching to VFM from premium.

Recently, BAT re-introduced Peter Stuyvesant (PS), which used to be a premium-type cigarette and is now branded as a VFM-type cigarette. Priced at RM7.80, PS will be BAT’s answer to counter JTI’s dominance in VFM via Winston.

The impact from the abolishment of the 14-stick cigarette pack from June is still at the early stage and yet to be realised. Estimated loss of margin is about RM80 million. We believe that in the long run, through cost savings via operational efficiency following a better streamlining of its production lines to produce packs of 20s and 25s, will help negate this loss. — Inter-Pacific Research Sdn Bhd


This article appeared in The Edge Financial Daily, July 26, 2010.