Earnings recovery expected for BAT as illicit trade decline seen

TheEdge Wed, Jan 16, 2019 10:59am - 5 years View Original


British American Tobacco (Malaysia) Bhd
(Jan 15, RM36.78)
Maintain buy with an unchanged target price (TP) of RM40.20:
Philip Morris International has launched its flagship tobacco heat-not-burn (HNB) electronic device, the iQos (I Quit Ordinary Smoking), in Malaysia. The electronic iQos heats tobacco, through “heets” sticks resembling elongated cigarette butts, at up to 350°C, thereby emitting dry vapour instead of smoke, produced by combusting conventional cigarettes at up to 900°C. Without combustion, Philip Morris claimed the vapour emitted by iQos generates significantly reduced levels of harmful compounds found in cigarettes.

Malaysia is the first Asean country to launch the iQos and HNB products. The former is sold at RM260 to RM420 depending on the model, and Heets refills at RM14 for a pack of 20s. Based on our channel checks, the devices are available at various dealers in the Klang Valley, with the refills largely sold at MyNews outlets.

While it is too early to garner the initial reception, we believe the iQos could be a game-changer for the local cigarette market, previously relatively insulated from smoking alternatives such as e-cigarettes amid regulatory uncertainty.

Based on robust demand in Japan, its maiden market, with a 16% tobacco market share in less than three years, and Korea with a 7% market share over a year, we believe Philip Morris’ iQos could similarly receive a strong reception in Malaysia, based on its affordability — with refills available at a 20% discount — relative to premium cigarettes and alternatives such as vaping and e-cigarettes, as well as purportedly reduced health risks from lower harmful contents emitted from heated tobacco.  

Consequently, we expect heated tobacco products’ introduction to cannibalise the traditional cigarette market. British American Tobacco (Malaysia) Bhd (BAT) had yet to announce any plans for its own HNB brand, Glo’s introduction.

However, with the iQos typically taking at least two quarters to gain traction, BAT still has some time to make up for Philip Morris’ first-mover advantage, while possessing a wider portfolio of alternative products. On the other hand, the launch of HNB products should initially deflate BAT’s margins.

Meanwhile, we noted the authorities taking positive actions following Budget 2019’s announcement to curtail the illicit cigarette market. This supports our thesis for a broad earnings recovery for legal tobacco players, particularly BAT commanding the leading market share. We’re holding on to our financial years 2018 to 2020 estimated earnings forecasts.

In our view, BAT with its heated tobacco products, is well-equipped to compete with the iQos, and we still expect a meaningful earnings recovery to materialise, underpinned by the envisaged decline in illicit trade. We reiterate our “buy” call on BAT, with an unchanged TP of RM40.20. Downside risks include slower-than-expected enforcement activities, regulatory hurdles, rising competition and excise duty shocks. — Affin Hwang Capital, Jan 15

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