BAT performance remains under pressure from cheaper illegal cigarettes

The impact from the illegal cigarette market is unlikely to abate considerably in the near term, says investment bank


BRITISH American Tobacco (M) Bhd’s (BAT) near-term outlook is expected to remain challenging due to stubbornly high illicit cigarette incidences, dwindling corporate market share and downtrading towards the value-for-money (VFM) segment.

Affin Hwang Investment Bank Bhd (Affin Hwang Capital) said the impact from the illegal cigarette market is unlikely to abate considerably in the near term, unless more radical enforcement is taken.

“Notwithstanding an overall legal industry contraction, BAT’s volume is seen to have registered an even sharper decline.

“The skew towards the VFM segment (Rothmans) at the expense of premium brands (Dunhill) will likely gain momentum going forward, given the increasing strain in affordability,” it wrote in a report last week.

BAT posted a stark volume decline of 21% year-on-year (YoY) in the first quarter of 2020 (1Q20) against the industry’s drop of 11% YoY.

This suggests an increasingly competitive landscape, especially from two other major tobacco players, JT International Bhd, a unit of Japan Tobacco Inc, and Philip Morris (M) Sdn Bhd, a subsidiary of Philip Morris International Inc.

Legal factory manufactured cigarette (FMC) volumes have been spiralling down over the years, recording on average 481 million sticks per month — more than half of the peak of 1,100 (million) sticks per month seen back in 2012.

Illegal cigarette trade remains by far the biggest challenge for the tobacco industry players, with illicit incidences hovering stubbornly high at 69%, comprising 58% illegal FMC and 11% illegal vape.

In addition, the lower-margin VFM mix will likely exert further pressure on BAT’s margin.

The full impact of Covid-19 will likely be seen in 2Q20, whereby the effective lockdown for one and a half months of the quarter would inevitably impact domestic cigarette sales and more so on duty-free channels.

“While we believe the second half of 2020 will fare better half-on-half as the economy gradually opens up, near-term earnings will likely remain volatile on the back of continued down-trading to the VFM segment, as well as a stubbornly high level of illicit trade.

“For 2020, we forecast core earnings to slide circa 30.2% YoY to RM252 million. Longer term, we are taking the stance that illegal tobacco trade is unlikely to abate in a sizeable and meaningful manner and thus, we expect bottomline earnings to remain on a downward trajectory for 2021 to 2022,” Affin Hwang Capital said.

The investment bank lowered its target price for BAT from RM10 to RM9.20, while reaffirming its ‘Sell’ call on the tobacco firm.

Shares of BAT closed 1.3% or 14 sen higher at RM10.76 last Friday, giving the group a market capitalisation of RM3.07 billion.