British American Tobacco - Saved by robust contract manufacturing biz HOLD

- We maintain our HOLD recommendation on BAT (British American Tobacco), but raise our DCF-based fair value to RM56.60/share (from RM49.10/share) based on our revised EPS and a terminal growth rate of 2.5% vs. 1% previously.

- BAT posted a higher net profit of RM601mil (YoY: 12%) for 9MFY12, coming in a tad ahead of our expectations. Earnings accounted for 82% of our initial full-year forecast and 77% of consensus.

- On a YoY basis, the improved performance for 9MFY12 was mainly attributable to:- 1) Benefits of higher contract manufacturing volumes (+48%) to new markets of Australia & Japan which more than offset a flat domestic sales volume and; 2) Lower opex (YoY: -18%) which boosted EBIT margin by +1.5ppts to 25%. Stripping out EI gains of RM39mil within opex, normalised net profit for 9MFY12 is still 4% higher YoY.

- On a sequential basis, 3Q net profit fell 16% QoQ mainly due to higher A&P expenses which crimped EBIT margin. This was despite a decent revenue growth arising from a surge in contract manufacturing volume for semi-finished goods (QoQ: +116%). 

- Compared to the same period in the preceding year, BAT’s cigarette sales volume declined by 5%, against the overall industry which expanded 5%. Nevertheless, we understand the underperformance was largely due to a more muted excise trade speculation this time around. Hence, we expect flattish 4Q earnings for BAT due to the limited impact from normalisation from de-stocking activities.

- Management declared a 3^rd  interim dividend of 65 sen, bringing total dividends to 195 sen YTD – 15 sen lower compared to the corresponding period in the preceding year. Our revised DPS forecast with yields of 4% is premised on a dividend payout ratio of 93% – in line with 9MFY12’s.

- All in, we have fine-tuned our FY12F-14F EPS higher by 9% to factor in:- 1) An upward revision in our margin  rate assumption due to better-than-expected cost containment efforts and lower finance costs; 2) A higher TIV growth rate of 0% to 2%, vs. 0% to -1% previously  and; 3) Impact from raised ASPs (2% to 2.4%) due to the recent government mandated increase in BAT’s ex-factory pricing (EFP) for cigarettes by 26%-58%. 

- Key downside risks include:- 1) Higher-than-expected illicit level (9MFY12: 34.9%); 2) Proliferation of ELPCs and illegal sale of cigarettes below the minimum pricing and; 3) A hike in tobacco excise duty.  

Source: AmeSecurities