BAT: Paying The Price of High Duties

Result Update

For QE31/3/2016, BAT's net profit dropped by 24% q-o-q or 6% y-o-y to RM196 million while revenue dropped by 9% q-o-q or 12% y-o-y to RM1.06 billion. Revenue declined 19.9% (or RM253 million) and Gross Profit declined 21.9% (or RM99 million) due to 34.0% -reduction in sales volume following  the  November  2015  steep  excise  increase.  Despite a drop in Operating Expenses, driven mainly by timing of administrative expenses, the huge drop in sales meant that operating overhead was "under-recovered". This led to a drop in Profit from Operations and Profit before Tax of 28.2% (or RM92  million) and 28.8%  (or RM94  million) respectively.


Table: BAT's last 8 quarterly results


Chart 1: BAT's last 36 quarterly results

Putting 4Q2015 in perspective

The sharp drop in revenue which began in QE31/12/2015 continued. That is the result of the unexpectedly jump in excise duties (off-budget!!). I had earlier expected the domestic sales is expected to recover in the next few quarters but the opposite has happened. This is partly due to the easy availability of illegal cigarettes as well as the difficult time affecting Malaysians of all walks of life.

Due to this challenging operating environment, BAT has announced its plan to restructure its business, which I reproduce below:  

Restructuring of Business Operations: On 17th March 2016, the Group announced that it will be restructuring its business operations by sourcing tobacco products for its domestic market from other BAT factories regionally and would cease its manufacturing operations located at Virginia Park, Jalan University, 46200, Petaling Jaya, Selangor. The winding down of factory operations will be carried out in stages and targeted to complete by the 2nd half of 2017.

The restructuring is in line with the Group’s efforts towards realising a new and more sustainable business model, amidst an increasingly challenging business environment. The higher excise environment has ultimately led to the sharp rise in illegal cigarettes and significantly lower legal sales volumes resulting in rising cigarette production costs. The restructuring will enable the Group to sharpen its commercial capabilities whilst optimising the supply chain and transactional activities to ensure that the Group remains a competitive consumer-focused market leader.

The winding down of the factory operations will affect approximately 230 employees and they will be provided with a benefit package as well as the option to undergo a career-transition programme. The equipment and machinery currently used for factory operations is intended to be sold to related parties within BAT group of entities.

The land upon which the factory operations are located will be disposed of by the Group by way of a public tender exercise. An independent real estate agent has been appointed by the Group to act for and on behalf of the Group to deal with all matters relating to the proposed disposal of the land. The public tender exercise is scheduled to complete on or about May 2016. An announcement in relation to the proposed disposal of land will be made after the sale and purchase agreement for the land is signed. Shareholders’ approval on the disposal will be sought in accordance with the Main Market Listing Requirement of Bursa Malaysia Securities Berhad.

I have posted earlier that this restructuring plan should be positive for the stock in the long run. Until then, investors will have to live with lower earnings for the next few quarters.
 
Valuation

BAT (closed at RM54.50 yesterday) is now trading at a PE of 18.4 times (based on the last 4 quarters' EPS of 295 sen). BAT paid out a dividend of RM2.89 for the last 4 quarters; thus giving a Dividend Yield of 5.3%. At these PER & DY, BAT is deemed fairly attractive.

Technical Outlook

At the current price of RM54.50, BAT has broken below the support from its long-term uptrend line, SS at RM55.00. Unless this breakdown is reversed quickly, BAT may continue to slide to its next support from the psychological RM50.00 mark.


Chart 3: BAT's daily chart as at April 26, 2016 (Source: ShareInvestor)

Conclusion

Despite the poorer financial performance, BAT is still a good stock for long-term investment based on fair valuation. However its technical outlook has turned bearish, I would revise the rating from long-term BUY to HOLD.

Note: 
In addition to the disclaimer in the preamble to my blog, I hereby confirm that I do not have any relevant interest in, or any interest in the acquisition or disposal of, BAT.