Sales and margins contracted again
? BAT’s 1Q22 core net profit made up 21% of our FY22F forecast. It was below
our expectation because the effective tax rate was higher than expected.
? We believe the group will once again face the yoy sales decline seen before
the pandemic’s emergence, although not to the extent of 1Q22’s 7.9% drop.
? We cut our FY22F EPS by 5% after factoring the Prosperity Tax’s impact on
the bottomline. Reiterate Reduce with lower DDM-based RM8.77 TP.
1Q22 review
British American Tobacco’s (BAT) sales went south in 1Q22, at a rate of 7.9% yoy and
39.5% qoq, after the stay-at-home order was lifted. The group’s 1Q22 core net profit
(removing a RM555,000 gain from fixed assets’ disposal) made up only 21% of our fullyear forecast and 18% of consensus’s FY22F estimate. It fell short of our expectation
because the 32.2% effective tax rate in the quarter was higher than the 26.6% that we
had assumed. Nonetheless, BAT’s 1Q22 sales performance is in line with our
expectation because we believe the group will fare moderately better qoq in subsequent
quarters. We suspect the big yoy drop in 1Q22’s sales was partly caused by commercial
proprietors front-loading their cigarette purchases in 4Q21 as sales in 4Q21 were 46%
higher than the quarterly average recorded in 9M21. The lower-than-expected 1Q22
earnings resulted in BAT issuing an equally disappointing first interim DPS of 17 sen.
Honeymoon period for sales growth may be halted after the MCO
BAT’s 1Q22 core net profit dropped by 18% yoy and 27.6% qoq on the back of dwindling
sales and margins. The group said the Omicron variant’s emergence had hurt its 1Q22
sales. We are of the view that this is unlikely to be the key reason since the Movement
Control Order (MCO) in 2020-10M21 had helped to shore up the group’s topline. BAT
also again blamed the black market cigarettes for ruining its growth trajectory. However,
as we have argued before, thriving illicit market demand is not the primary problem but a
symptom of the affordability issue plaguing the tobacco industry (see our proprietary
analysis on cigarette prices in various countries against their populations’ incomes in our
15 Feb 2019 Alpha series company note, “No longer affordable”). BAT’s sales only
recovered during the MCO because we believe a large segment of smokers had larger
disposable incomes after their social activities were curtailed. Now, they will have less
money for legal cigarettes after spending on petrol, eating out, and other commitments.
Reiterate Reduce, DDM-based TP cut to RM8.77
We cut our FY22F EPS by 5% after adding the Prosperity Tax’s impact. Our DDM-based
TP drops to RM8.77 after raising our risk-free rate from 3% to 4.5% (based on the 10-
year Malaysian Government Securities’ yield), which lifts the COE from 8.4% to 9.9%. In
our view, Malaysia’s regulatory framework is working against the tobacco industry’s
efforts to grow its sales. Upside risks: the government rescinds the “generation end
game” proposal for cigarette sales and tones down the vape liquid excise duty.