ECM Libra Investment Research has reiterated its hold recommendation on British American Tobacco (Malaysia) Bhd (BAT) at RM41.25, and maintained target price of RM42 due to the counter's high dividend yield and strong brand portfolio.

It said that BAT's 2Q08 results announced yesterday were above its estimates, as revenue and net profit both made up 53% and 61% of its financial year estimates due to productivity savings and absence of discounting despite gross profit margins eroding marginally year-on-year.

"Net profit margins improved marginally to 19.3%, compared to 19.0% in 2Q08. However, based on a quarter-on-quarter comparison, profit margins eroded due to higher advertising and promotional expenditures as illicit trade levels increased," it said.

ECM Libra said BAT's revenue and earnings improved marginally year-on-year as higher pricing and better sales mix offset lower sales volume.

It said total industry volume (TIV) declined 3.7% year-on-year to 7.8 billion sticks in 1H08 due to increasing levels of illicit trade and exceptionally low priced cigarettes, adding that the incidence of illicit trade has increased to 24.9% from 23.8% in 2007.

"However, BAT's market share improved to 61.4% from 61.1% in 1H07 due to the performance of Dunhill and Pall Mall as both brands increased market share year-on-year in the premium (41.6%) and value-for-money (8.1%) segment respectively," it said.

Commenting on the tax exempt RM1.13 per share interim dividend declared by the company, the research house said it expects BAT to generate gross dividend yield of 7.1% for FY08 assuming 95% payout ratio.

On the pictorial health warnings (PWH) to be implemented for cigarette packs sold beginning Dec 1, the research house said BAT would incur a one-time cost of about RM10 million.

"However, BAT said they are unable to quantify the exact total costs as they are still waiting for the finalized guidelines on how to go about implementing the PHW," it said.

ECM Libra said the risks to its recommendation included a significant tax hike; lower than expected TIV and further profit margin erosion due to higher than expected advertising and promotion.