Analysts divided on British American Tobacco’s outlook following results

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KUCHING: Kenanga Investment Bank Bhd (Kenanga Research) and AmInvestment Bank Bhd (AmInvestment Bank) are divided on their opinion on British American Tobacco (Malaysia) Bhd’s (BAT) outlook.

In separate reports, Kenanga Research upgraded their call on the BAT stock to ‘outperform’ while AmInvestment maintained its ‘sell’ call on the stock.

The conflict follows the release of BAT’s second quarter financial year 2017 results, whereby BAT declared a net profit to RM151.6 million which saw a quarter over quarter (q-o-q) increase of 26 per cent and a year over year (y-o-y) increase of 13 per cent.

The results were largely in line with both analysts’ expectations – meeting 51 and 44 per cent of AmInvestment Bank and Kenanga Research’s full year earnings estimates for FY17.

Additionally,profit after tax margins also saw expansion by 5.7 points, largely due to BAT’s exit from its manufacturing operations into a purely trading based operation.

Moving forward, both analysts are expecting better margins to trend favourably in tandem with the completion of its restructured operations, which will provide better support for earnings going forward.

“The full impact of its cost savings is expected to be realise in FY18F,” guided AmInvestment Bank.

Despite the group posting results widely within expectation of both analysts, the reason for their divided in opinion lies in the anticipation of regulatory hurdles and competition of substitution products.

“We like BAT’s foresight and adaptability to transform its modus operandi into a trading model to negate high fixed costs.

“However, we think that regulatory hurdles and disruptive substitute tobacco products may prove too steep to overcome,” explained AmInvestment Bank.

The bank went onto detail that that this was due to two main reasons, the potential move for Malaysia to implement a similar measure akin to the Australian tobacco plain packing ruling, and a potential increase in tobacco excise duties.

“Over the past 14 years, the longest time span authorities left tobacco excise duties unchanged was 36 months. This was between October 2010 and September 2013.

“Therefore, we anticipate an excise duty hike in 2HFY18 as the last hike took place in November 2015.

“We also do not think it will be earnings accretive to BAT as in the past, as cigarette demand is no longer as elastic,” said the bank.

On the end of the spectrum, Kenanga Research has taken a different approach at looking at BAT’s outlook by focusing on the declining market share of illicit tobacco and noting that its challenges are appearing to ease.

Recent data on the illicit market share have shown a small but well received improvement to 58 from 59 per cent, marking the first market share decline in 10 months.

“This could be attributed by more stringent enforcements, which developed in the past several months,” said the research arm.

While the decline of illicit tobacco market share is optimistic, it is still likely that illicit trade will continue dominating the industry as high cigarette prices continue to dampen consumer incentives to source from the legal market.