British American Tobacco - Leading the way with Dunhill HOLD

-  Following our meeting with management, we re-affirm our HOLD rating on British American Tobacco (BAT) with an unchanged fair value of RM56.60/share. Our DCF-based valuation pegs BAT at 20x its FY13F earnings.

-  BAT is on course for its third consecutive year of market share growth since registering a positive growth in FY10, the first time in a decade. At end-9M12, it garnered a market share of 62.5% (+1.5% from FY11), thanks largely to its ability to defend its stronghold premium segment (share of premium: 72%).

-  BAT’s premium brand, Dunhill, saw its market share achieve a new high of 47.8% in September 2012, while its 9M12 market share had risen by 2.4ppts from FY11’s 44.7%. We attribute this to uptrading activities from higher disposable incomes along with Dunhill’s first-mover advantage in introducing switch/capsule technology domestically. 

-  Nonetheless, we caution that Philip Morris (PMI) remains a credible threat to BAT should the premium segment pie (+3.5ppts for 9M12) begin to shrink. PMI’s 9M12 market share has grown 2.2ppts YoY to 15.2% on the back of the success of its own capsule cigarette, Marlboro Ice Blast. 

-  With regard to the value-for-money (VFM) segment, management indicated that the focus moving forward would be on growing  Pall Mall. We note that despite BAT’s VFM segment underperformance of 1.2ppts against the broader industry’s decline of 0.6 of a ppt,  Pall Mall and  Peter Stuyvesant’s share of market had steadied in 2H12.

-  We reckon BAT will ramp up its subcontract manufacturing deals given the softer domestic legitimate TIV growth going forward (FY13F-FY14F: 0% to +1% against FY12F’s +2%). With high industry operating leverage, the enlarged revenue base will help move BAT’s profits in an upward trajectory.

-  Thus far, management has recommended dividends of 195 sen. Our dividend forecast of 255 sen for FY12F, 261 sen for FY13F and 266 sen for FY14F are premised on a 93% dividend payout, similar to 9M12’s. These translate into yields of 4%-4.3%, below its historical 6%-7%.

-  Key risks to the stock include:- (1) a potential hike in excise duty in 1H13; (2) imminent regulatory amendments in 1Q13; (3) persistently high level of illicit cigarettes (34.9%); and (4) the proliferation of ELPCs – cigarettes sold below the mandated minimum price of RM7.00/pack.

-  At this juncture, we believe the stock is fairly valued. Post the run-up in its share price, BAT’s dividend yield has also faded.  Nonetheless, we believe BAT’s share price will be supported by a need for a relatively safe consumer play as well as offer of a stable return.  

Source: AmeSecurities