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British American Tobacco - Dividend up, shares down

George Salmon | 22 February 2018 | A A A
British American Tobacco - Dividend up, shares down

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No news or research item is a personal recommendation to deal. All investments can fall as well as rise in value so you could get back less than you invest.

British American Tobacco plc Ordinary 25p

Sell: 2,701.50 | Buy: 2,702.50 | Change 27.00 (1.01%)
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Despite reporting a lower than expected organic volume decline of 2.6%, BATs' organic revenue growth and total sales both came in below market expectations.

The shares fell 4.5% on the news.

The full year dividend increased 15.2% in 2017, to 195.2p per share.

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Our View

Headline volumes are falling, but that's a more or less inevitable consequence of operating in the tobacco industry.

BATS has been able to offset volume declines through a combination of shifting smokers on to higher margin products and hiking prices. Dominant market position and an addictive product translates into tremendous pricing power.

This has helped BATS generate high margins and prodigious amounts of cash. Most of it can be returned to shareholders through dividends (which have grown every year since 1999) and share buybacks. At present the shares offer a prospective yield of 4.5% next financial year.

Recent weakness in the share price has seen the yield on offer rise recently. Part of this is due to a stock market-wide retrenchment, brought on by fears of interest rate hikes.

BATS and other equities with attractive income potential came into favour when interest rates hit record lows. Low rates depressed yields on bonds, thus drawing income-starved investors from the bond market to defensive stocks like BATS, which helped boost share prices. The threat of this unwinding is sparking falls in defensive stocks like BATS.

There are other more specific headwinds too. Tobacco is subject to numerous regulatory risks, for example the introduction of plain packaging in France, the UK and Ireland. Shortly after returning to the US via the acquisition of Reynolds, the regulator there threatened to cut nicotine content to non-addictive levels.

At 14 times expected earnings, BATS trades on a discount to its own recent average, but a higher multiple than UK rival Imperial Brands. This reflects the different characteristics of the two companies.

BATS can claim higher growth potential thanks to its exposure to faster-growing emerging markets, and is putting more resource into next generation products.

The revenues from the 'heat not burn' glo brand may be insignificant in the context of the wider group at the moment, but in an industry in terminal decline it's the long-term potential that matters.

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Full year results

2017 revenue rose 37.6% to £20.3bn. This was boosted by the completion of the Reynolds acquisition, organic sales growth of 2.9% and foreign exchange movements.

Operating margin of 31.9% was up 0.3 percentage points on an adjusted basis, with price increases again a contributing factor. That led operating profit up 39.1%, or 3.7% after adjusting for acquisitions and currency movements.

Market share grew 0.4 percentage points, driven by the Global Drive Brand portfolio, with volumes up 7.6% on an organic basis.

Following the Reynolds deal, US sales were £4.2bn, with adjusted operating profits of £2.1bn.

Organic revenue growth was strongest in the Americas, rising 10.8% at constant currency to £3.2bn. Canada, Chile and Colombia all performed well. Growth was much lower in BATS' other regions, between 0.6% and 1.3% in Asia-Pacific, Western Europe and EEMEA.

Net debt was £45.6bn, up from £16.8bn last year, with the Reynolds deal playing a major part in the increase.

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Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.