British American Tobacco (BATS) announced adjusted profits of $5.2bn for the full year, up 4.1% at constant currency, with earnings per share up 10.4%. The group has announced a final dividend of 118.1p per share, taking the full year dividend to 169.4p. This represents a 10% increase on 2015.
The shares were broadly flat following the announcement.
For the first time in a long time, currencies are moving in BATS's favour. Emerging markets, which currently account for around 70% of BATS' sales, have seen their currencies depreciate sharply against the dollar over the last couple of years. That has caused a headache for BATS as higher raw material costs led to margin pressure. Lower sterling has more than offset that headwind this year.
Underneath the currency movement's BATS has continued to perform well. True, headline volumes are falling but that's a more or less inevitable consequence of operating in the tobacco industry. More importantly, the group has proven more than capable of offsetting that decline in revenue by hiking prices and shifting smokers onto higher margin products.
BATS has a great track record and generates prodigious amounts of cash, most of which can be returned to shareholders through dividends (which have grown every year since 1999) and share buybacks. It benefits from dominant market positions and sells an addictive product, which translates into tremendous pricing power.
The pending acquisition of Reynolds American is no surprise. BATS has been a long term shareholder in the business and M&A has been central to the tobacco industry's success in recent years; as companies look to grow scale in the face of ever increasing competition. With US litigation largely a thing of the past, BATS has been drawn back to what is one of the world's most lucrative tobacco markets.
The deal is expected to be accretive to earnings and, perhaps more importantly, dividends from year one, making it attractive for shareholders. With many institutional investors already holding both companies, it's difficult to imagine the deal not getting the green light.
It's worth bearing in mind though that tobacco is subject to numerous regulatory risks. The introduction of plain packaging in France, the UK and Ireland a good example. But BATS' geographic diversity and exposure to faster growing emerging nations should stand it in good stead in the long run.
The shares are trading on a price to earnings ratio (P/E) of 17.3 times, a 19% premium to their long run average rating. BATS shares currently offer a prospective yield of 3.6%.
Full year results:
With the vast majority of revenues generated outside the UK, BATS is a significant beneficiary of lower sterling. The group delivered a 6.9% increase in revenues at constant rates, driven by improved pricing. Including the boost from favourable currency movements, reported revenue growth was 12.6%.
Organic cigarette volumes across the group declined 0.8%, outperforming the wider market which saw volumes fall 3%. Underlying the group level decline, BATS' Global Drive Brands (which includes Dunhill, Kent, Pall Mall and Lucky Strike) saw volume growth of 7.5%, increasing market share by 1 percentage point. The group continued to grow market share in its key markets, which collectively represent 80% of group volume.
BATS' has continued to grow its e-vapour and tobacco heating businesses. With Vype now present in 10 markets, BATS' vapour business is now the largest in the world outside the US. The group also launched its Tobacco Heating product, glo, in Japan.
On 17 January 2017, the group announced the agreed terms of a recommended offer for the acquisition of the remaining 57.8% of Reynolds American it does not already own. BATS expect the transaction to close in Q3 2017, subject to obtaining the relevant approvals.
Unless otherwise stated, all estimated figures, including prospective dividend yields, are taken from a consensus of analyst forecasts compiled by Thomson Reuters. These estimates should not be taken as a reliable indicator of future performance.
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