HDBSVR: British American Tobacco, Buy (Initiating Coverage)

British American Tobacco: A defensive play

-Story: BAT, the manufacturer of Dunhill and Pall Mall cigarettes in Malaysia, has been able to retain its leadership despite competition from the influx of exceptionally low priced cigarettes (ELPC) and contraband cigarettes. As at 31 Dec 2007, BAT commanded a retail market share of 60.3%, followed by its rivals: JT International (JTI) 18%, Philip Morris (PMI) 13.5% and ELPC 8.2%.

-Point: BAT has historically distributed up to 100% of its earnings as cash dividend to shareholders. For FY07, BAT has declared a total of 256.5 sen net DPS, translating into 6.0% dividend yield. Going forward, we expect BAT to pay out at least 90% of earnings in FY08F (240 sen) and FY09F (249 sen), with implied yield of 5.6% and 5.9%, respectively, to shareholders. This is premised on our forecast EPS of 266 sen and 277 sen, respectively.

-Relevance: We re-initiate coverage on BAT with a BUY call and a DDM-derived target price of RM47.00. BAT is currently trading at 1-year forward PE of 16.0x against its 5-year historical range of 13x-23x. YTD, the share price has gained 3.0%, outperforming KLCI's 12.9% drop. The stock offers investors a defensive equity exposure amidst the prevailing uncertainties in the Malaysian bourse. Based on the last closing price, BAT offers 10.6% potential upside from our target price, and 5.9% net dividend yield. These add up to a probable total return of 16.5%.