• Maintain NEUTRAL with new MYR11.50 TP from MYR13.50, 9% upside. British American Tobacco’s 1H22 results met consensus’ expectations but missed our optimistic forecasts. Current valuation may have priced in most of the negative sentiments which arose from the proposal to ban the sale of tobacco products to those below 18 years old, although we believe the near- term earnings impact is muted. In addition, the stablilised legal TIV volume and BAT’s dominant market share should sustain the attractive dividend yield of c.10% and cap further downside.

• BAT’s 1H22 results were below our expectations but in line with consensus’. Net profit of MYR126m (-7% YoY) met 49% of the Street’s estimates but only 45% of ours as we were too optimistic with our volume assumptions. Post results, we trim FY22F earnings by 5%. Correspondingly, our DCF-derived TP drops to MYR11.50 (no adjustment to our ESG score of 3.0) as we take the opportunity to tweak our risks assumptions to factor in the rising interest rates. Our new TP implies 11x P/E FY23F or close to -1SD of the stock’s 5-year mean, which we believe is fair to reflect both BAT’s challenges and entrenched fundamentals.

• Results review. YoY, 1H22 revenue was flat at MYR1.2bn, on the back of a flattish volume growth trend as illicit trade market share was kept under control (57.7% in May 2022 vs 57.3% in 2021). 1H22 gross profit inched up 2% on a 0.5ppt GPM expansion, likely due to a more favourable product mix. However, 1H22 PBT fell 3% as opex grew 9% which we believe was due to higher marketing spend. 1H22 effective tax rate was higher at 30.4% (1H21: 27.4%) on Cukai Makmur adjustments which caused a steeper dip in bottomline. QoQ, 2Q22 revenue jumped 22% to MR637m with volume spiking 21% following the broader reopening of economy. Correspondingly, 2Q22 net profit surged 40% QoQ to MYR73m.

• Outlook. The legal TIV volume should sustain at current level premised on the broad containment of the pandemic and stabilised illicit trades market shares. That said, further upside from hereon should be capped considering the affordability factor. Meanwhile, the regulation of vaping, even if passed, is unlikely to lift earnings immediately, considering the potential gestation period and similar price gap disadvantage vs illegal products. The proposal to ban the sale of tobacco products to those below 18 years old is a sentiment dampener as longer-term volume outlook will be dented, subject to the effectiveness of execution. However, we believe the near-term earnings impact is muted as underage smokers are not likely the consumers of legal cigarettes.

• Risks to our recommendation include higher/lower-than-expected TIV, and favourable/unfavourable regulatory or policy changes.

Source: RHB Research - 22 Jul 2022