Company Update

Earnings & Valuation Summary

FYE 31 Dec 2018 2019 2020E 2021E 2022E Revenue (RMm) 2,822.9 2,508.6 2,157.4 2,259.7 2,340.2 EBITDA (RMm) 623.0 506.7 360.1 373.4 386.1 Pretax profit (RMm) 623.0 462.3 328.3 357.1 371.6 Net profit (RMm) 468.5 345.7 249.5 271.4 282.4 EPS (sen) 164.1 121.1 87.4 95.0 98.9 PER (x) 8.5 11.6 16.0 14.7 14.2 Core net profit (RMm) 449.2 361.1 249.5 271.4 282.4 Core EPS (sen) 157.3 126.5 87.4 95.0 98.9 Core EPS growth (%) (14.0) (19.6) (30.9) 8.8 4.1 Core PER (x) 8.9 11.1 16.0 14.7 14.2 Net DPS (sen) 155.0 118.0 83.1 90.3 94.0 Dividend Yield (%) 11.1 8.4 5.9 6.5 6.7 EV/EBITDA 6.9 8.7 11.5 10.9 10.5 Chg in EPS (%) - +9.0 +18.5 Affin/Consensus (x) 1.0 1.1 1.1 Source: Company, Affin Hwang estimates

RM14.00 @ 8 December 2020

Share price performance

1M 3M 12M Absolute (%) 37.0 38.3 -10.6 Rel KLCI (%) 27.8 29.0 -13.9

BUY HOLD SELL

Consensus 5 9 3

Source: Bloomberg

Stock Data

Sector Consumer

Issued shares (m) 285.5

Mkt cap (RMm)/(US$m) 3997.4/981.7

Avg daily vol - 6mth (m) 0.7

52-wk range (RM) 9.26-15.84

Est free float 45.9%

Stock Beta 0.88

Net cash/(debt) (485.6)

ROE (CY21E) 65.4%

Derivatives Nil

Shariah Compliant No

Key Shareholders

British American Tob. 50.0% Blackrock Inc 2.7% Oversea Chinese Bank 1.9% Source: Affin Hwang, Bloomberg

0.00

5.00

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15.00

20.00

25.00

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35.00

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Dec-17 Jun-18 Dec-18 Jun-19 Dec-19 Jun-20 Dec-20

(RM)

Chow Wei Nien

T (603) 2146 7579

E weinien.chow@affinhwang.com

British American Tobacco (ROTH MK)

BUY (upgrade) Price Target: RM16.20 Up/Downside: +15.7% Previous Target (Rating): RM9.20 (Sell)

Likely to have bottomed out

BAT’s VFM offerings have by and large seen a good traction, and are poised

to provide a steady earnings base for the group moving forward.

Pronounced measures laid out in Budget 2021 are likely to remain

supportive of near-term sentiment. For every 1% reduction in illicit

volumes, the impact to the 2021E earnings is +3%, based on our estimates.

We revise higher our earnings forecasts for 2021-22E by 9-18%, inputting

higher VFM volume sales. Further upside risk may transpire from the

reduction in illicit volumes. Upgrade to BUY, with a higher TP of RM16.20.

Steady earnings base from VFM offerings

The previous two quarters saw BAT’s domestic volume increase 15% / 14% qoq for

2Q20 / 3Q20, outpacing the industry’s growth of +10%/+7% qoq. This led to a market

share gain of 2.1ppt to 52.5% over the period. Much of the volume improvement

could be attributed to VFM offerings, Kyo and Rothmans, which garnered strong

traction on the back of increased down-trading towards more economical variants.

Notwithstanding the lower-margin nature of VFM offerings, we expect the growing

volume sales to offset the lower profitability, and support sequential earnings

improvement.

Reduction in illegal volumes is an added bonus

Limiting the transhipment of cigarettes to dedicated ports and the initial imposition of

import taxes are seen as keys to eliminate a major loophole in the tobacco black

market. It is believed that 30-40% of illegal volumes are brought in via transhipments.

Hence, if successfully executed, a blue-sky scenario would imply an elimination of

almost c.4.5bn illegal cigarette sticks per year. For every 1% reduction in illicit

volumes, we estimate an increase in the 2021E net profit of around 3%.

All-round positive developments; upgrade to BUY

We revise up our earnings estimates by 9-18% for 2021-22E, largely inputting higher

VFM sales. Meantime, we lowered our CoE assumption to 8.2% (from 10%),

reflecting the prospects of better containment of the illegal market, and gradual return

to normalcy in 2021. Since the announcement of Budget 2021, BAT’s share price

has appreciated by c.37%, largely as investors have turned more upbeat on

prospects of better control of the illegal tobacco market. We foresee further upside

from the current juncture, and hence upgrade the stock to BUY with a higher DDM-

derived TP of RM16.20.

9 December 2020

“Earnings likely to have bottomed out in 2020”

2

Seeing better FMC volume

Regaining some market share

BAT’s market share in the legal tobacco space has seen a decline over the years

(61% in 2015), owing to an increasingly competitive landscape, particularly from the

other 2 major tobacco players - Japan Tobacco International (JTI) and Philip Morris

International (PMI) - likely on better marketing strategies and better brand appeal.

Nevertheless, the past two quarters saw BAT’s domestic volume increase 15% / 14%

qoq for 2Q20 / 3Q20, outpacing the industry’s growth of 10% / 7% qoq. This led to

its market share improving by 2.1ppt to 52.5% from a trough in 4Q19 / 1Q20.

Fig 1: BAT domestic volume (m sticks) Fig 2: Market share of BAT

Source: Company Source: Company

… thanks to VFM brands Kyo and Rothmans

Much of the market share gain can be attributed to BAT’s VFM portfolio, Kyo and

Rothmans. The launch of Kyo in July 2020 has garnered promising traction,

underpinned by the increased down-trading towards more economical variants.

Based on the latest data as at 1H20, the VFM segment share stood at 28%, against

that of premium at 56% and aspirational premium at 16%. Notwithstanding the lower-

margin nature of VFM offerings, we expect the growing volume sales to offset the

lower profitability, and boost sequential earnings growth.

Stronger foothold in VFM segment

Having a stronger foothold in the VFM segment may prove to be a crucial

differentiator, in our view, especially at a time when a switch-back from illegal

cigarettes may transpire given the ongoing clampdown by authorities. Although our

projected EBIT margins at c.16% for 2021-22 are lower than for previous years, we

envisage the bottom-line to progressively recover from the 2020 trough, backed by a

healthy sales uptrend as the group gradually recoups its market share.

Fig 3: Breakdown of Premium, Aspirational premium, VFM Fig 4: Revenue and EBIT

Source: Company Source: Company

274 284262

297

225

258

294

0

50

100

150

200

250

300

350

1Q19 2Q19 3Q19 4Q19 1Q20 2Q20 3Q20

sticks/month (m)

50.8%

50.4% 50.4%

51.5%

52.5%

49.0%

49.5%

50.0%

50.5%

51.0%

51.5%

52.0%

52.5%

53.0%

3Q19 4Q19 1Q20 2Q20 3Q20

BAT market share

24.4%

21.6% 21.8%19.6%

16.0% 16.1% 16.1%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

-

500.0

1,000.0

1,500.0

2,000.0

2,500.0

3,000.0

3,500.0

4,000.0

FY16 FY17 FY18 FY19 FY20F FY21F FY22F

(RM m)

Revenue EBIT EBIT margin

3

More pronounced fight against illegal market

RM5bn loss in tax collection annually due to tobacco black market

Since 2014, the illegal tobacco market share has crept up from 35% to 65% as of

3Q20. Given the dwindling legal cigarette volumes sold by tobacco players, the

Malaysian government has seen reduced excise collection from them. In particular,

the excise collection from BAT has shrunk from RM2.1bn in 2014 to RM1.3bn in

2019. On a whole, it is estimated that the tobacco black market resulted in tax

revenue losses of c.RM5bn annually, or about 3% of the total federal government tax

revenue of RM180.6m in 2019.

Fig 5: Legal FMC industry share over the years

Source: Company, Affin Hwang forecasts

Regulating transhipment expected to plug major leakages

A total of six constructive measures have been laid out in Budget 2021. Amongst

others, limiting the transhipment of cigarettes to dedicated ports and the initial

imposition of tax on imports are seen as keys to eliminate a major loophole in the

tobacco black market. Given that taxes will now have to be paid upfront until the

eventual re-export of goods, this stands to significantly reduce the abuse of the

transhipment facility.

Measures to be implemented effective 1 Jan 2021

#1: Freezing the issuance of new import licence for cigarettes

#2: Tightening the renewal of import licence for cigarettes

#3: Limiting transhipments of cigarettes to dedicated ports

#4: Imposition of tax on import of cigarettes with drawback facilities for re-export

#5: Disallow transhipment of cigarettes by small boats (only through ISO containers)

#6: Making tobacco products taxable goods in all duty-free islands and other free

zones

30-40% of illegal FMC sticks are from transhipments

Of the estimated c.11bn annual illegal cigarette sticks, it is believed that 30-40% are

brought in via transhipments. Hence, if successfully executed, a blue-sky scenario

would imply an elimination of almost c.4.5bn illegal cigarette sticks per year. We

observed that over the past 6 months alone, as seen from available news flows, there

has been a rather active clampdown on illegal cigarettes (Fig 6). Based on our

estimates, for every 1 ppt switch-over to legal cigarettes, the potential impact to our

2021E net profit estimate is +3%.

63.9% 65.5% 64.3% 64.2%55.0%

42.0% 37.0% 37.0% 32.0% 35.0% 35.5%

-100.0%

-80.0%

-60.0%

-40.0%

-20.0%

0.0%

20.0%

40.0%

60.0%

80.0%

100.0%

-

5,000

10,000

15,000

20,000

25,000

30,000

2011 2012 2013 2014 2015 2016 2017 2018 2019 9M19 9M20

(m sticks)

Estimated industry volume Legal cigarette volume Legal market share (%)

4

Fig 6: News on contraband cigarettes clampdown Fig 7: Legal market share to net profit sensitivity

Source: Affin Hwang Source: Affin Hwang forecasts

Mixed impact from taxation in duty-free zones

We understand that duty-free sales contribute to less than 4% of total group turnover.

Hence, we view the impact of the imposition of tax on cigarettes and tobacco

products sold in duty-free zones as likely to be minimal, more so if tourist arrivals and

the number of domestic travellers remain subdued in the near term. From the

government’s perspective, it is likely that the move would potentially strengthen its

tax revenue collection, as this would de-incentivise parties from illegally channelling

these duty-free items to other states in Malaysia without the payment of taxes. On

the other hand, we note that the move could backfire as higher taxes in these duty-

free zones may deter consumers from buying legal cigarettes, and instead cause

them to turn to illegal FMC, which may render the move counterproductive.

Valuation and Recommendation

Projecting sequential improvement post-2020

In anticipation of a return to normalcy in 2021, we are of the view that BAT’s earnings

may well have bottomed out in 2020. As such, we revise up our 2021-22E earnings

forecasts by 9-18%, largely inputting overall higher sales growth assumptions

especially for the VFM segment, post the pandemic-hit year. Elsewhere, the onset of

new measures may bode well in putting BAT back onto a recovery path and should

support an upbeat sentiment in the near term. While the effectiveness of the said

measures is yet to be seen, any switch-over from the illegal market would be an

added bonus and an upside risk to our forecasts, in our view.

Fig 8: Core net profit and yoy change

Source: Company, Affin Hwang forecasts

Date News Source Location Value

19-Nov-20 Malay Mail Kajang & Cheras RM321,000

14-Nov-20 Malay Mail Port Klang RM363,440

5-Nov-20 Malay Mail Kempas RM135,600

7-Oct-20 The Edge Port Klang RM500,000

13-Aug-20 FMT Johor & Negri SembilanRM6,100,000

23-Jul-20 FMT Labuan RM2,240,000

23-Jul-20 Malay Mail Yong Peng RM301,892

18-Jun-20 The Star Bintulu RM6,300,000

Total RM16,261,932

2021E Legal Market Share

271 34% 35% 36% 37% 38%

-2% 245.9 253.3 260.6 267.9 275.2

-1% 248.5 255.9 263.3 270.7 278.1

0% 251.0 258.5 266.0 273.5 280.9

1% 253.6 261.1 268.7 276.2 283.8

2% 256.1 263.7 271.4 279.0 286.6

3% 258.6 266.3 274.1 281.8 289.5

4% 261.2 269.0 276.7 284.5 292.3

5% 263.7 271.6 279.4 287.3 295.1

Industr

y g

row

th

(14.0)

(19.6)

(30.9)

8.8

4.1

(35.0)

(30.0)

(25.0)

(20.0)

(15.0)

(10.0)

(5.0)

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2018 2019 2020E 2021E 2022E

(RM m)

Core net profit (RMm) Growth yoy

(%)

5

Earnings look to have bottomed out; upgrade to BUY

We lower our CoE assumption to 8.2% (from 10%), reflecting the prospects of better

containment of the illegal market and tracking the slew of positive developments on

Covid-19 vaccines. Post-revision, we arrive at a higher DDM-derived TP of RM16.20.

This implies a 2021E PER of 17x, near 1SD below its 5-year mean. Our new TP also

implies a generous forward yield of 5.6%, reflecting its mean over a 5-year period.

We foresee further upside from the current juncture, and hence upgrade the stock to

BUY.

Key Risks

Downside risks: (i) worse-than-expected enforcement outcomes, (ii) excise-duty

reversals, and (iii) less competition from alternative products.

Fig 9: 5-year dividend yield band Fig 10: 5-year PER band

Source: Affin Hwang forecasts Source: Affin Hwang forecasts

0.0%

1.0%

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4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

10.0%

Dec-15 Dec-16 Dec-17 Dec-18 Dec-19 Dec-20

Average +1SD -1SD +2SD -2SD

Avg: 4.8%

1SD: 6.5%

2SD: 8.1%

-1SD: 3.2%

7.0

12.0

17.0

22.0

27.0

32.0

37.0

De

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Jun-1

6

De

c-1

6

Ju

n-1

7

De

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ROTH MK EQUITY +1SD Average -1SD +2SD -2SD(x)

-2SD: 11x

+1SD: 27x

Avg: 22x

Dec 20: 15x

+2SD: 33x

-1SD: 16x

6

Financial Summary – BAT

Source: Company, Affin Hwang estimates

Profit & Loss Statement Key Financial Ratios and Margins

FYE 31 Dec (RMm) 2018 2019 2020E 2021E 2022E FYE 31 Dec (RMm) 2018 2019 2020E 2021E 2022E

Revenue 2,822.9 2,508.6 2,157.4 2,259.7 2,340.2 Growth

Operating expenses (1,927.8) (1,790.9) (1,595.8) (1,658.8) (1,718.1) Revenue (%) -6.0 -11.1 -14.0 4.7 3.6

EBITDA 623.0 506.7 360.1 373.4 386.1 EBITDA (%) -4.9 -18.7 -28.9 3.7 3.4

Depreciation (7.0) (14.2) (14.2) (9.3) (8.7) Core net profit (%) -14.0 -19.6 -30.9 8.8 4.1

EBIT 616.0 492.5 345.9 364.1 377.4

Net int income/(expense) (12.2) (14.8) (17.6) (7.0) (5.8) Profitability

Exceptional items 19.3 (15.4) - - - EBITDA margin (%) 22.1 20.2 16.7 16.5 16.5

Pretax profit 623.0 462.3 328.3 357.1 371.6 PBT margin (%) 22.1 18.4 15.2 15.8 15.9

Tax (154.5) (116.6) (78.8) (85.7) (89.2) Net profit margin (%) 15.9 14.4 11.6 12.0 12.1

Net profit 468.5 345.7 249.5 271.4 282.4 Effective tax rate (%) 24.8 25.2 24.0 24.0 24.0

Core net profit 449.2 361.1 249.5 271.4 282.4 ROA (%) 40.8 35.1 26.4 29.0 29.5

Core ROE (%) 106.5 92.9 62.2 65.4 65.9

Balance Sheet Statement ROCE (%) 54.0 44.6 35.6 39.6 40.4

FYE 31 Dec (RMm) 2018 2019 2020E 2021E 2022E Gross dividend payout ratio (%) 92.4 98.5 93.3 95.0 95.0

Fixed assets 44.0 65.5 56.4 52.2 48.6

Other long term assets 444.4 432.4 432.3 432.3 432.2 Liquidity

Total non-current assets 488.4 497.9 488.7 484.4 480.8 Current ratio (x) 0.9 0.9 0.9 0.9 0.9

Op. cash flow (RMm) 493.7 331.1 507.8 336.1 294.9

Cash and equivalents 78.6 20.4 147.5 183.8 199.6 Free cashflow (RMm) 477.0 323.7 502.8 331.1 289.9

Stocks 162.3 98.3 153.0 136.3 141.2 FCF/share (sen) 1.7 1.1 1.8 1.2 1.0

Debtors 361.5 402.9 147.8 123.8 128.2

Other current assets 10.3 8.6 8.6 8.6 8.6 Asset managenment

Total current assets 612.7 530.2 457.0 452.6 477.7 Debtors turnover (days) 43.0 55.6 25.0 20.0 20.0

Stock turnover (days) 37.8 26.5 35.0 30.0 30.0

Creditors 235.9 170.7 196.7 204.5 211.8 Creditors turnover (days) 48.5 41.4 45.0 45.0 45.0

Short term borrowings 410.0 421.0 300.0 270.0 270.0

Other current liabilities 33.6 26.1 26.1 26.1 26.1 Capital structure

Total current liabilities 679.4 617.7 522.8 500.6 507.9 Net gearing (%) 0.8 1.0 0.4 0.2 0.2

Interest cover (x) 47.0 29.2 19.2 36.5 39.9

Long term borrowings 0.0 0.0 0.0 0.0 0.0

Other long term liabilities 0.0 21.8 21.8 21.8 21.8

Total long term liabilities - 21.8 21.8 21.8 21.8 Quarterly Profit & Loss

FYE 31 Dec (RMm) 3Q19 4Q19 1Q20 2Q20 3Q20

Shareholders' Funds 421.7 388.6 401.1 414.6 428.7 Revenue 584.3 662.4 481.1 546.6 627.5

Operating expenses (422.8) (470.6) (358.1) (406.6) (468.1)

Cash Flow Statement EBIT 112.6 138.4 71.4 83.0 87.8

FYE 31 Dec (RMm) 2018 2019 2020E 2021E 2022E Net int income/(expense) (3.8) (4.3) (4.4) (4.9) (3.9)

PBT 623.0 462.3 328.3 357.1 371.6 Interest and other income - - - - -

Depreciation & amortisation 7.0 14.2 14.2 9.3 8.7 Associates' contribution - - - - -

Working capital changes (1.7) (52.8) 226.5 48.4 (2.0) Exceptional Items - (15.4) (4.6) (6.1) (3.1)

Cash tax paid (154.5) (116.6) (78.8) (85.7) (89.2) Pretax profit 108.8 134.1 66.9 78.1 83.8

Others 7.6 9.2 0.0 0.0 0.0 Tax (25.7) (36.4) (16.2) (23.5) (20.1)

Cashflow from operation 493.7 331.1 507.8 336.1 294.9 Minority interest 1.0 1.0 1.0 1.0 1.0

Capex (16.7) (7.4) (5.0) (5.0) (5.0) Net profit 83.1 97.7 50.8 54.6 63.7

Others 2.7 5.7 0.4 3.0 3.7

Cash flow from investing (14.0) (1.7) (4.6) (2.0) (1.3) Margins (%)

Debt raised/(repaid) 32.0 11.0 (121.0) (30.0) 0.0 EBIT 19.3 20.9 14.8 15.2 14.0

Dividends paid (431.2) (376.9) (237.0) (257.8) (268.3) PBT 18.6 20.2 13.9 14.3 13.4

Others (13.5) (21.7) (18.0) (10.0) (9.4) Net profit 14.2 14.7 10.6 10.0 10.2

Cash flow from financing (412.7) (387.6) (376.0) (297.8) (277.8)

Free Cash Flow 477.0 323.7 502.8 331.1 289.9

7

Important Disclosures and Disclaimer

Equity Rating Structure and Definitions

BUY Total return is expected to exceed +10% over a 12-month period

HOLD Total return is expected to be between -5% and +10% over a 12-month period

SELL Total return is expected to be below -5% over a 12-month period

NOT RATED Affin Hwang Investment Bank Berhad does not provide research coverage or rating for this company. Report is intended as information only and not as a

recommendation

The total expected return is defined as the percentage upside/downside to our target price plus the net dividend yield over the next 12 months.

OVERWEIGHT Industry, as defined by the analyst’s coverage universe, is expected to outperform the KLCI benchmark over the next 12 months

NEUTRAL Industry, as defined by the analyst’s coverage universe, is expected to perform inline with the KLCI benchmark over the next 12 months

UNDERWEIGHT Industry, as defined by the analyst’s coverage universe is expected to under-perform the KLCI benchmark over the next 12 months

This report is intended for information purposes only and has been prepared by Affin Hwang Investment Bank Berhad (14389-U) (“the Company”) based on sources believed to be reliable and is not to be taken in substitution for the exercise of your judgment. You should obtain independent financial, legal, tax or such other professional advice, when making your independent appraisal, assessment, review and evaluation of the company/entity covered in this report, and the extent of the risk involved in doing so, before investing or participating in any of the securities or investment strategies or transactions discussed in this report. However, such sources have not been independently verified by the Company, and as such the Company does not give any guarantee, representation or warranty (expressed or implied) as to the adequacy, accuracy, reliability or completeness of the information and/or opinion provided or rendered in this report. Facts, information, estimates, views and/or opinion presented in this report have not been reviewed by, may not reflect information known to, and may present a differing view expressed by other business units within the Company, including investment banking personnel and the same are subject to change without notice. Reports issued by the Company, are prepared in accordance with the Company’s policies for managing conflicts of interest. Under no circumstances shall the Company, be liable in any manner whatsoever for any consequences (including but are not limited to any direct, indirect or consequential losses, loss of profit and damages) arising from the use of or reliance on the information and/or opinion provided or rendered in this report. Under no circumstances shall this report be construed as an offer to sell or a solicitation of an offer to buy any securities. The Company its directors, its employees and their respective associates may have positions or financial interest in the securities mentioned therein. The Company, its directors, its employees and their respective associates may further act as market maker, may have assumed an underwriting commitment, deal with such securities, may also perform or seek to perform investment banking services, advisory and other services relating to the subject company/entity, and may also make investment decisions or take proprietary positions that are inconsistent with the recommendations or views in this report. The Company, its directors, its employees and their respective associates, may provide, or have provided in the past 12 months investment banking, corporate finance or other services and may receive, or may have received compensation for the services provided from the subject company/entity covered in this report. No part of the research analyst’s compensation or benefit was, is or will be, directly or indirectly, related to the specific recommendations or views expressed in this report. Employees of the Company may serve as a board member of the subject company/entity covered in this report. Third-party data providers make no warranties or representations of any kind relating to the accuracy, completeness, or timeliness of the data they provide and shall not have liability for any damages of any kind relating to such data. This report, or any portion thereof may not be reprinted, sold or redistributed without the written consent of the Company. This report is printed and published by: Affin Hwang Investment Bank Berhad (14389-U) A Participating Organisation of Bursa Malaysia Securities Berhad 22nd Floor, Menara Boustead, 69, Jalan Raja Chulan, 50200 Kuala Lumpur, Malaysia. T : + 603 2142 3700 F : + 603 2146 7630 research@affinhwang.com www.affinhwang.com