British American Tobacco - FY12: A smoking good year HOLD

- We re-iterate our HOLD recommendation on British American Tobacco (M) Bhd (BAT) with an unchanged fair value of RM56.60/share. This implies a PE of 20x FY13F earnings.

- BAT posted a 4QFY12 net profit of RM197mil, up 6% QoQ, and FY12 net profit of RM798mil (+11% YoY), meeting both our, and consensus, forecasts.

- The group declared a fourth interim dividend of 77 sen/share, tax-exempt under the single-tier system. Its FY12 dividends now stand at a total of 272 sen (97% payout ratio), translating into a decent yield of 4.7%.

- The commendable YoY earnings growth comes on the back of improved sales volume and much lower operating expenses (-18% YoY), due mainly to lower corporate incentives (RM42mil) and the absence of one-off costs (merchandising assets write down, redundancy costs and accounts related matters) in FY11 of RM46mil.

- After nearly a decade of lackadaisical volume expansion, BAT managed to grow its volumes by 0.24% to 8.7bil sticks in FY12 while increasing, for the third consecutive year, its overall market share by 1.6ppts to 62.5% in FY12.

- Nonetheless, this pales in comparison to the legitimate industry’s growth of 6%, which comes on the back of:- (1) the status quo excise duty of 22 sen/stick; (2) waning threat of ELPCs (3.8% market share from 6.4% in FY11); and (3) declining illicit volumes (-1.6ppts YoY to 34.5%).

- Sustained uptrading (as a result of higher disposable incomes given the consumer friendly 2012/13 budget) had fuelled the continuous growth of the premium segment. YoY, this segment grew 3ppts at the expense of VFMs (-0.4ppts) and ELPCs. With a 72% hold on the premium segment, BAT was the direct beneficiary of this step-up, driven by its Dunhill brand (47.3% cigarette market share, YoY: +2.6ppts). We expect Dunhill to chart a higher market share as it strengthens its brand equity further through the introduction of new lines in FY13F.

- We reckon BAT will ramp up its contract manufacturing deals given the positive contribution from this division. Its FY12 net turnover was up 192% underpinned by a volume growth of 39%. In addition, this division helped improve BAT’s EBIT margins, which grew 1ppt in FY12 to 25%, as it can now earn margins on both materials as well as conversion costs.

- Going forward, we believe the tobacco industry’s prospects are expected to remain challenging. We do not rule out the risk of an excise duty hike following a 2-year reprieve, as well as more regulatory changes in 2013.

Source: AmeSecurities