British American Tobacco (M) - Time to Quit!

By Maybank IB Research13 September 2012

Downgrade to SELL. BAT’s valuations are at their peak and  its dividend yield has dropped to  a 10-year low following a run-up in its share price – a rising risk to investors. We expect 2H12 earnings to be largely flat as BAT’s market share growth has lost momentum in the last two quarters. Upside is also limited due to the competitive environment and rising threat from the illicits. Hence, we downgrade BAT to a SELL at an unchanged DCF-based TP of MYR55.00.


Dividend yield tapering off. BAT’s share price has surged  by  25% YTD and  its  FY12  net  dividend yield  has  fallen to  4.0%, significantly below its 10-year historical average of 5.9%. We believe this signifies rising downside risk to  its share price. In addition, BAT’s lofty stock valuation is unjustified given its 3-year net profit CAGR of 6%. At a 1-year forward PER of 21x, the  stock is trading  significantly above 1SD over its 5-year forward mean PER of 17x. Our DCF-based target price meanwhile translates into 18x FY13 PER

Flattish 2H12. The robust 15% YoY growth in BAT’s 1H12 net profit was largely due to  a 25% YoY decline in  operating costs  while sales volumes crept up 1.6% YoY. However, 22% of the cost reduction is due to timing differences. We expect BAT’s 2H12 earnings to be flattish HoH as costs normalise, and we see limited upside to sales volumes. There is no change to our estimates.  We forecast  FY12  net profitgrowth at 10% YoY; 1H12 net profit accounted for 53% of our estimate.

Slowing market  share gains? BAT’s quarterly market share growth has diminished during the last two quarters while its 1H12 market share increased 0.2ppt YoY, matching JTI’s 0.3ppt increase but behind PMI’s 2.6ppt YoY market share growth. Aside from the stiff competition from its peers, the new variant of illicits could have gained market share as VFM brands including BAT’s Pall Mall and Peter Stuyvesant and JTI’s Winston have been losing market share despite aggressive marketing initiatives. Thus, we see limited upside to BAT’s sales volume growth.Sell (from Hold)Share price: MYR62.00Target price: MYR55.00 (unchanged)

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