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British American Tobacco - guidance up on market share growth

Sophie Lund-Yates, Equity Analyst | 9 December 2020 | A A A
British American Tobacco - guidance up on market share growth

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British American Tobacco plc Ordinary 25p

Sell: 3,280.50 | Buy: 3,281.50 | Change 11.00 (0.34%)
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British American Tobacco's full year revenue growth is now expected to be towards the top of the previously announced 1-3% range, excluding foreign exchange movements.

The group said it has gained market share and the overall market is not shrinking as quickly as previously forecast. New Categories performance, such as vapour, was also broadly positive across the group's major brands.

As a result earnings per share are expected to rise by mid-single digits, despite headwinds from COVID-19 and around a £200m increase in investment in New Categories.

The shares were broadly flat following the announcement.

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Our view

Tobacco consumption in developed markets has been in decline for decades. However, the sheer size of BATs sales are still mind-blowing - if you put all the tobacco sold last year in standard sized cigarettes and laid them end to end you'd reach to and from the moon over 60 times.

That scale combined with incredible pricing power has resulted in operating margins other consumer goods companies can only dream of. What's more, demand for cigarettes has held up as well during the coronavirus pandemic.

A dominant market position and an addictive product has repeatedly seen the group hike prices while moving customers onto premium products. With relatively low capital requirements the group's delivered prodigious amounts of cash despite falling volumes.

A lot of that cash is currently tied up in stabilising a balance sheet that's carrying considerably more debt than we would like, but it still leaves a sizeable surplus that can be returned to shareholders through dividends (which have grown every year since 1999 to date) - but are never guaranteed.

The major question facing the group, and the whole industry, is whether it can continue to squeeze ever more revenue from an ever smaller number of customers.

BATS is notable for its significant emerging market exposure, especially in Latin America and Asia which is a potential advantage when it comes to growth. But it's also got a strong position in the US, and that's a market with a surprising amount of potential. There's room for BATS to push up prices and grow margins, and since the US is by far the group's biggest region by revenue that would be good news for profits.

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

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 is why BATS has decided to spend big on New Categories like e-vapour and heated tobacco. These make up a small part of the picture at the moment, but are growing quickly and key to the long-term.

Emerging market exposure and a superior New Category position means BATS shares continue to trade ahead of UK peer Imperial Brands. However, a valuation of 8.4  times future earnings, is significantly below its longer term average. We suspect the threat of increased regulation and the ever increasing number of investors seeking ethical investments is behind the valuation fall. They're not trends that are likely to reverse any time soon, and that makes a return to historic valuation levels unlikely.

BATS key facts

  • 12m forward Price/Earnings ratio: 8.4
  • Ten year average 12m forward Price/Earnings ratio: 13.9
  • Prospective yield of 7.7%

All ratios are sourced from Refinitiv. Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

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First Half Results (underlying and constant currencies, 31/07/20)

Underlying revenues rose 1.1% in the first half to £12.3bn, driven by growth in group's strategic portfolio where revenues reached £9.4bn. Operating profits rose 3.3% to £5.4m, as revenue growth and cost savings, offset increased investment into New Categories.

The next quarterly dividend payment of 52.6p per share will be paid in August, as part of the previously announced dividend of 210.4p per share which is payable in four equal instalments.

BAT's headline revenue growth was the result of higher cigarette prices offsetting the 6.5% decline in volumes, and higher revenue in new categories - notably vapour and modern oral in the US. The negative impact of coronavirus on group revenue was estimated at 4%.

In the US revenue of £5.6bn, was 9.7% higher than last year and operating profits followed suit up 9.6% at £2.6bn. That reflects higher prices in Combustibles and strong volume growth in new categories with Vapour revenues up 70.3%. Underlying operating profits rose 9.6% to £2.7bn.

Asia Pacific and Middle East revenues fell 10.5% to £2.1bn, driven by lower volumes. Coronavirus was said to have impacted a number of markets and global travel retail in particular. These declines were reflecting in underlying operating profits which fell 6.9% to 904m.

In Europe and North Africa revenue rose 3.0% to £2.8bn and profits were up 2.9% at £944m. Headline cigarette volumes declines were offset by strong pricing and strong New Categories performance in Eastern Europe.

In the Americas and Sub-Sahara Africa revenues fell 0.9% to £1.8bn, as growth in cigarette pricing and new categories' volumes, was more than offset by the 8.4% decline in cigarette volumes. Coronavirus was linked to the contraction in multiple markets but particularly in South Africa, where there's been a ban on cigarette sales since March. Underlying profits fell 3.6% to £787m.

Higher cash from operating activities and a £1.3bn tax deferral in the US, saw free cash generated nearly double to £2.4bn. Net debt was £42bn, largely in line with the end of 2019.

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

This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. 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.

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