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British American Tobacco - On track for the full year

Nicholas Hyett | 27 November 2019 | A A A
British American Tobacco - On track for the full year

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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: 3,203.00 | Buy: 3,205.00 | Change -41.50 (-1.28%)
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Full year adjusted revenue is expected to be at the top of the group's 3-5% guidance range, and operating profit at the top of the 5-7% range. This reflects a strong performance in Combustibles, more than offsetting a slowdown in the US vapour market.

The shares were broadly flat following the announcement.

View the latest BATS share price and how to deal

Our view

A dominant market position and an addictive product translates into tremendous pricing power.

By hiking prices and shifting customers on to more premium products, BATS has been able to deliver impressively high margins and prodigious amounts of cash despite falling tobacco volumes.

Continued growth in cash flows is crucial to stabilising a balance sheet that's carrying considerably more debt than we would like, but also leaves a sizeable surplus that can be returned to shareholders through dividends (which have grown every year since 1999) and share buybacks. The shares currently offer a prospective yield of 7.4%, although as ever there are no guarantees.

BATS is notable for its significant emerging market exposure, especially in Latin America and Asia. But it's also got a strong position in the US, and that's a market with a surprising amount of growth potential, with plenty of room for BATS to push prices up, and grow margins. America is by far BATS' biggest region, so the ability to pump up margins here would have significant repercussions.

However, the tobacco industry isn't having things all its own way across the pond.

Increasing regulation, particularly in US menthol, is a potential worry. There's been talk of banning menthol cigarettes completely, and given the dominant position of BATS' Newport Brand, this would be an unwelcome blow. Any drastic change in the law won't happen overnight, but it's certainly something investors should be keeping an eye on.

A prickly regulatory environment and falling tobacco volumes help explain why BATS has decided to spend big on Next Generation Products (NGPs) like e-vapour and heated tobacco. These make up a small part of the picture at the moment, but are key to long-term growth. Unfortunately, a spate of heath scares in the US have significantly impacted the local vapour market. Interestingly, BATS is keen for more regulation here. It's no stranger to regulatory scrutiny after all, which should give it a head start over newer competitors.

Emerging market exposure and a superior NGP position means BATS shares trade at 8.7 times expected earnings- ahead of some peers. However, that's significantly below its own longer term average, reflecting concerns that debt levels and increased regulation could upset the apple cart.

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First Half Trading Update

Global tobacco volumes are expected to fall by around 3.5% this year, in line with previous expectations. However, BATS is growing market share, particularly among its Strategic Brands such as American Spirit and Newport.

Despite falling volumes, BATS expects both revenue and operating profit to grow, reflecting stronger pricing and improved margins.

The group has not changed its expectations of around 5.5% volume declines in the US market, and a 4-6% decline is expected next year. However, the group still expects to grow revenue between 3-5% in the region, and Strategic Brands took market share.

BATS expects New Categories revenue growth to be at the lower end of its 30-50% guidance range, reflecting a slowdown in the US vapour market. If the US results were excluded, growth would be in the middle of the range. However, the Vuse brand grew its US market share to 17.5%, while Vype grew to 11.8% in the UK and 19.2% in France.

BATS confirmed it's on track to reduce net debt to cash profits by about 0.4% this year, as it generates around £1.5bn in free cash after dividends.

Find out more about British American Tobacco shares including how to invest

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 disclosure for more information.