Inflationary pressure could kick in in 3Q22F
- Despite 2Q22’s earnings improving yoy and qoq, BAT’s 1H22 core net profit was within our expectation at 51% of our full-year forecast.
- The 39% qoq jump in BAT’s 2Q22 core net profit did not surprise us as 1Q22 sales were hit by advanced purchases in 4Q21.
- We believe BAT’s sales may not be able to surpass pre-2019 levels due to unfriendly regulations and poor enforcement. Reiterate Reduce.
The business environment was not like-for-like in 2Q22 vs. 2Q21
British American Tobacco’s (BAT) 2Q22 core net profit of RM72.2m (after removing RM1m worth of fixed asset disposal gains) was 0.8% higher yoy, while sales appreciated by 7% yoy. Looking at the headline numbers, it may seem that we were wrong in our thesis that the economic re-opening would cause more smokers to eschew legal cigarettes because their disposable incomes would have to be put towards financial commitments and subject to inflationary pressure. However, we believe the numbers may be difficult to compare on a yoy basis as there was a drastic drop in Jun 2021’s sales volume – which BAT attributed to the re-imposition of the Movement Control Order (MCO) at the time. Additionally, BAT’s gross margin rose from 2Q21’s 25.1% to 26.3% in 2Q22. BAT said that Dunhill’s market share climbed 0.9% pts yoy between Jan and May 2022. We observe a growing trend of higher-income smokers buying Dunhill and premium cigarette brands as a status symbol of sorts. BAT’s second interim DPS of 25 sen brings YTD DPS to 42 sen, which falls within our expectation (FY22F DPS: 83 sen).
2Q22 earnings in line despite core net profit rising 39% qoq
The qoq improvement in 2Q22 appeared impressive at face value. Sales in the quarter jumped 22% qoq, while core net profit rose 39.6% qoq. While BAT credited the better qoq performance in 2Q22 to the economic re-opening, the group’s 1Q22 earnings were at abnormally low levels, as we suspect it was hit by commercial proprietors front-loading their cigarette purchases in 4Q21 (BAT’s 4Q21 revenue was 46% higher than the quarterly average recorded in 9M21). Therefore, we were not surprised by the strong qoq rebound in BAT’s 2Q22 revenue and core net profit. 1H22 core net profit, subsequently, made up 51% of our full-year forecast and 49% of consensus, coming in line with our expectation.
The return of high-income smokers, in our view, may not help to fuel BAT’s earnings growth going forward. For one, those who can afford legal cigarettes are few and far between. The majority, we argue, could be worse off come 3Q22 as the quarter has already seen spikes in the prices of daily goods. Thus, we reiterate our Reduce call and RM8.77 DDM-based TP (COE: 9.9%). The 7.8-7.9% CY22-24F dividend yields are outweighed by the 16.6% potential capital downside. Upside risks: the government rescinds the “generation end game” proposal for cigarette sales and lowers the vape liquid excise duty.