KUALA LUMPUR: As inflation takes a bite out of consumer spending, smokers are switching out their regular tobacco for cheaper brands, which could potentially eat into the margins of manufacturers like British American Tobacco (M) Bhd (BAT).
Kenanga Research, which expects BAT's sales volume to sustain going into FY23, said it remains cautious over the downtrading trend in the market, which could see consumers move away from the company's higher-margin segments or make a complete shift to black market cigarettes.
"Given the group controls the lion’s share of the premium segment, their leading Dunhill brand could be at risk of losing volume if consumer sentiment worsens," it said in a note.
On a brighter note, however, the research firm said proposed government regulation could offer a more positive outlook on the year ahead.
While Budget 2023 is due to be re-tabled on Feb 24, the proposed regulations by the Multi Agency Task Force in the earlier version were largely in line with what was discussed during the group's meetings with government officials.
"Recall, during 3QFY22, Malaysia saw a 1.6ppt decrease in illicit volume following an uptick of inland seizures," said Kenanga.
It added that the group is also not immediately concerned with the generational ban on cigarettes given it is also yet to be re-tabled.
Overall, Kenanga said BAT was largely positive over measures proposed in the previous version of Budget 2023, which included subsidies and cash hand outs to support consumer spending.
Kenanga is also more upbeat on BAT's FY23 earnings forecast following the release of its FY22 results yesterday, which came within the research firm's expectations.
The tobacco company posted a net profit of RM263mil, which was 7.8% lower than in the previous year mainly owing to the effect of the one-off Prosperity Tax.
"We raise our FY23F net profit by 5% as we feel slightly more upbeat on sales volume, taking our cue from a resilient FY22. This will be offset partially by a shift towards the VFM segment," it said.
The research firm reiterated "market perform" on the stock while raising its target price to RM12 from RM11.45 previously.
Kenanga said it likes BAT for its relatively stable market demand in the medium-term following the reopening of the economy as well as its leading position in the high-margin premium cigarette segment with its Dunhill brand.
It is also positive on BAT being the largest player within the legal tobacco market with 51.5% of the legal market share.
On the downside, the research firm said it was wary of the lack of catalysts for longer-term growth as well as rising health consciousness dampening demand,
"While the stock may appeal to yield seekers due to its high dividend yield of 7.7%, we also see limited prospects given the rising interest rate environment," it added.
Kenanga cautioned that risks include more restrictions on sales of tobacco and duty hikes, illicit trade eating into the legal market and rising risk premium as ESG investing gains traction.