BAT to reinvest opex savings in marketing for new products

This article first appeared in The Edge Financial Daily, on January 6, 2020.

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British American Tobacco (Malaysia) Bhd(Jan 3, RM15.18)Upgrade from reduce to hold with an unchanged target price (TP) of RM15.45: British American Tobacco (Malaysia) Bhd’s (BAT) share price has plunged by 19.2% since it announced its third quarter of financial year 2019 (3QFY19) earnings on Oct 31, 2019. At the current level, the stock is technically a “hold” which provides a 1.6% theoretical upside and is supported by a 7.4% FY20 forecast (FY20F) dividend yield.
The company still faces potential challenges, such as: i) the one-off redundancy costs for about 100, or 20%, of its employees, which would affect its FY19F dividend per share (DPS); ii) higher near-to-mid-term distribution and marketing costs from the potential legalisation of electronic cigarettes and vaporiser products; and iii) more existing legal smokers switching to vapes.
When BAT shut down its manufacturing plant in 2016-17, it paid out a total of RM8.9 million in voluntary redundancy packages over those two years — about 230 employees were laid off, which worked out to RM38,808 per employee. Using this average amount as a reference for the upcoming retrenchment of 100 of its employees, BAT’s FY19F DPS may drop by 1.2% or 1.3 sen from our base-case forecast of RM1.14. However, as this round would affect the corporate employees, the cost per employee may be higher.
In the event the government approves e-cigarettes and vapes as regulated products, BAT has said that it aims to reinvest any operating expense (opex) savings in marketing for new products. The marketing for its heat-not-burn product, Glo, already seems aggressive, with the opening of dedicated shops, lower pricing of its device compared with its competitor’s IQOS, and the use of social media influencers for promotion.
We upgrade BAT due to its recent pullback elevated FY20-21F yields to above 7%, which we see as attractive. However, its earnings decline may not abate anytime soon. This could pose a risk of shrinking yield over the years. The smoking ban at eating premises may also affect smoking frequency among Malaysians. — CGS-CIMB Research, Jan 3

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