British American Tobacco (BATS) is upgrading its full year revenue growth expectations from 3-5% to above 5%. Underlying earnings per share are expected to be grow by mid-single digits. This performance is being driven by strong pricing in combustibles and accelerating growth in New Categories.
The group added 1.4m non-combustible customers in the first quarter, bringing the total to 14.9m. The geographic recovery is weighted towards Emerging Markets, although the US also saw a robust performance despite an unclear outlook. No recovery is expected in Global Travel Retail until 2022.
The shares rose 2.0% following the announcement.
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 out end to end you'd reach to and from the moon almost 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 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. The UK, EU and Turkey have already made the move, although the impact has been "immaterial" as smokers just switched to other products. Investors may hope the group can similarly weather a US ban. Potentially even more concerningly, we're starting to hear whispers of nicotine limits - although these are still unconfirmed.
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 8.2 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: 8.2
- Ten year average 12m forward Price/Earnings ratio: 13.6
- Prospective yield of 8.1%
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.
Full Year Results (underlying and constant currencies, 17/02/21)
British American Tobacco's full year adjusted revenue, which excludes the impact of exchange rates, grew 3.3% to £25.8bn. This was driven by growth in both Combustibles and New Category items. Excluding exchange rate movements, restructuring and litigation costs, operating profit rose 4.8% to £11.4bn.
The group announced a full year dividend of 215.6p per share, up 2.5% on last year and equal to 65% of adjusted earnings per share.
Overall Combustibles sales rose 2.8% to £23.6bn. This was driven entirely by price increases, as volumes fell 4.6%. New Categories grew sales 15.4% to £1.4bn.
US revenue rose 11.2% to £11.5bn, primarily reflecting 9.9% growth in Combustibles to £10.0bn. This growth was driven by price increases, as volumes only grew 0.5%. New Categories revenue grew 82.9% to £396m, primarily thanks to the strength of Vapour, and the Vuse brand in particular. Operating profit rose 15.5% to £5.8bn.
Asia Pacific and Middle East revenues fell 9.9% to £4.6bn, driven by a 7.2% fall in volumes. This was largely because of reduced Global Travel Retail, excise tax increases and minimum pricing in Indonesia. Combustibles revenue fell 7.7% to £4.0bn and New Categories revenue fell 25% to £507m. The fall in New Categories revenue was driven by increased excise taxes in Japan and a poor performance from the Sens brand which has been withdrawn. Operating profit fell 7.3% to £1.9bn.
In Europe and North Africa revenue rose 2.1% to £6.2bn and operating profits were down 2.4% at £2.1bn. Combustibles revenue rose 0.5% to £5.5bn as volumes fell 4.1%. New Categories revenue rose 49.6% to £478m thanks to strength in THP and Modern Oral. Vapour revenue grew just 0.2% despite a 23% rise in volumes as BATs cut prices to drive sales.
In the Americas and Sub-Sahara Africa revenues rose 1.4% to £4.3bn, as price increases and New Categories growth offset declining Combustibles volumes and pandemic related restrictions, notably in South Africa. Operating profit fell 2.5% to £1.8bn.
Free cash flow after dividend payments rose 32.7% to £2.6bn, thanks to higher cash generation and lower capital spending. Adjusted net debt fell 5.3% to £39.5bn, which is 3.3 times adjusted cash profits. The group plans to bring this ratio down to around 3.0 times in the current financial year.
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.
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