BAT-tered down

FOR those of you who are familiar with Petaling Jaya, one of its most famous roundabouts is the “Rothmans roundabout”.

The roundabout was named after the giant tobacco company Rothmans of Pall Mall (Malaysia) Bhd’s manufacturing plant, Virginia Park, which was located just a stone’s throw away from the roundabout. The company itself underwent a mega-corporate exercise following the merger of Rothmans and Malaysian Tobacco Company Bhd in November 1999.

That merger created what is known today as British American Tobacco Malaysia Bhd (BAT).

Hence, while the company changed its name more than two decades ago, the roundabout is still known by its original name and despite being altered to what it is today with a signalised four-lane traffic light in 2011, the name Rothmans roundabout is still well known among the older folk.

Ironically, the name Rothmans is still being used by the financial markets to a certain extent, as although the company’s name today is BAT, its ticker symbol in Bloomberg remains as “ROTH MK Equity”.

Another interesting fact is that BAT itself has now ceased its business operations from this location due to a tough business environment, and hence, one can say that while the Rothmans roundabout is no longer around, the company itself too has ceased its manufacturing operations after 55 years, in the very location it was famous for.

BAT’s share price recently hit a level not seen in the past four decades as its share price plummeted to a low of RM10.22 early this week – a level last seen in the early 1990s – before some bargain hunting edged it up to RM12 by Thursday’s close. The rise and fall of BAT over the past 40 years can be seen in Chart 1.

What is interesting about BAT is that over the years, it has gone through the ups/downs of the tobacco industry, growing rapidly in the early years and hitting peak performance in 2014 when revenue leaped to almost RM4.8bil, generating after-tax profits of RM902mil in that year and puffing out dividends as high as RM882.3mil.

The strong performance in 2014 was again almost repeated in 2015 as revenue, although falling to RM4.58bil, did not dampen the company’s performance. Net earnings were sustained at RM910mil, while dividends peaked at about RM891mil. In terms of earnings per share (EPS) and dividends per share (DPS), they both peaked in 2015 as well at 318.7 sen and 312 sen, respectively. Since then, due to the rising incidence of the illicit trade and hikes in tobacco duties and taxes, BAT’s topline has been hard hit.

The last reported nine-month results ended Sept 30,2019 showed that BAT’s revenue was just below RM1.85bil, while earnings and dividends have slumped to just about 87 sen and 85 sen, respectively – down as much as 64% from its peak performance in 2015 on an annualised basis. The summary of BAT’s operating performance is shown in Chart 2.

As can be seen in both Charts 1 and 2, the strong revenue, earnings and dividends were clear drivers of BAT’s share price and it didn’t come as a surprise when BAT’s share price hit a peak of RM74.40 in early December 2014. BAT then was a KLCI-linked stock, as its market capitalisation was in excess of RM20bil and by the time the market price was half from its peak level in 2017, the stock had lost its position and was removed from the 30-elite companies that are part of the benchmark index.

BAT’s fall since its peak in late 2014 was due to several factors: the significant increase in duties and taxes for tobacco companies; the rise of the illicit trade that has caused substantial loss of revenue for both the government and tobacco companies; the substitution effect that comes from the vaping industry; and the tougher anti-smoking laws in Malaysia.

Among these four reasons, the first and second factors are inter-related, as the rise in taxes caused significant increases in cigarette prices, and with it, the spread between the legal and illegal cigarette prices widened. This led to some form of substitution in the market, as smokers down-traded their habits towards cheaper market alternatives. As demand for cheaper alternatives grew, the incidence of illicit trade too rose in tandem.

According to a report commissioned by the Confederation of Malaysian Tobacco Manufacturers (CMTM) - “Illicit Cigarettes Study (ICS) in Malaysia 2019 Wave 2 (June-Aug) Report” - the incidence of illicit cigarettes has been rising rapidly and more so over the past five years. This is also in line with BAT’s own financial performance, as the rise in the illicit trade saw BAT’s own revenue and profitability being impacted severely. Chart 3 shows the growth in the illicit activities over the period and as at the June-Aug 2019 period, this had reached almost 65% of the market – almost double the level seen in 2014.

In terms of the component of the illicit trade in the market, CMTM’s data suggests that about 44.6% of the 64.9% in illicit trade is from smuggled whites, 12.9% is from smuggled kreteks and another 7.1% from fake tax stamps. The incidence of fake tax stamps is on a significant rise as there were none in 2015.

The winners and losers of the illicit trade

The winners are obviously the consumers, as they are able to sustain their habits at a much cheaper cost against a pack of cigarettes that today costs RM17.40 for 20 sticks. The other winners are the smugglers, as they are able to increase their trade at the expense of the legalised market.

What used to be a sustained and matured market with a steady flow of dividends has now been replaced with rising uncertainty, especially in the form of a lower legal market share, and hence lower revenue, earnings and dividends.

Investors who had bought BAT shares are also sitting on huge mark-to-market losses and just about a year ago, BAT’s share price was still decent at about RM38.00 per share.

The lower volume from the legalised market has also made an impact on society and led to job losses, as both BAT and JT International have to shut down their respective manufacturing facilities.

What can the government do?

The significant rise in the illicit trade over the past few years means the government needs to step up enforcement activities and clamp down on this rising trend of contraband cigarettes. The government has raised the minimum fine to RM100,000 or a minimum jail term of six months or both for those caught selling or smuggling cigarettes from this year onwards.

The government has also stepped up cargo scanning at our port of entries to ensure we are able to not only detect but prevent smugglers from entering Malaysia with contraband cigarettes. Under Budget 2020, an allocation of RM235mil was made for this purpose to purchase 20 additional scanners.

These are good measures but like all other measures, implementation and enforcement is key. Judging by the rapid increase in the illicit trade, the numbers suggest that the smugglers are having a field day in the market as they are either not detected or our borders have been compromised.

Clearly, the fall in BAT’s share price is highly correlated to the level of illicit trade in the market and if the government is able to combat these smugglers and the whole support chain (by the way, this is also part of our shadow economy which according to our Minister of Finance is worth RM300bil). BAT could see brighter days ahead, but until then, it remains a challenge to not only BAT but the whole tobacco sector, which includes the farmers too.

While BAT seems to be badly BAT-tered down by the development within the tobacco sector, especially those related to hikes in duties and taxes as well as the significant rise in the illicit trade, it is hoped that the government will take the necessary steps to restore the industry’s equilibrium. After all, there’s no smoke without fire!

The views expressed are the writer’s own.

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