British American Tobacco (BATS) remains on track to achieve full year revenue growth between 2% and 4% excluding the impact of exchange rates.
BATS expects a ''strong'' improvement in operating margin, despite increasing input cost inflation. Higher selling prices are one factor behind this.
This is against a backdrop of a slower than expected decline in the tobacco industry, driven by continued post COVID recovery in emerging markets.
The Group reiterated its 2025 target for new categories, which includes the Vuse brand, to reach £5bn revenue, and to achieve profitability over the same timeframe. In the first 9 months of the year BATS grew customer numbers in these categories by 17.5% to 21.5m.
Cash conversion remains strong and year end net debt is expected to land at the upper end of its 2-3 times cash profit target.
The shares were down 2.2% following the announcement.
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Our view
Tobacco consumption in developed markets has been in decline for decades. However, BATS is a juggernaut, with revenue expected in the region of £28bn this year.
That scale combined with incredible pricing power has resulted in operating margins other consumer goods companies can only dream of. And, with relatively low capital requirements, the group's delivered prestigious amounts of cash despite falling volumes.
A lot of that cash is currently tied up in stabilising a balance sheet that's carrying a hefty pile of debt, following the $49bn acquisition of Newport a few years ago. With finance costs on the increase we would expect a continued focus on debt reduction. But it still leaves a sizeable surplus that can be returned to shareholders through dividends (which have grown every year since 1999 to date) and a £2bn buyback programme for 2022. Remember though, no returns are ever guaranteed.
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 also has a strong position in the US, and that's a market with a surprising amount of potential. So far BATS has been able to push up prices and grow margins. But with US smokers starting to focus on value, profit growth may become more challenging in 2023.
There's also the threat of increasing regulation, particularly in US menthol, which is a potential worry. There's been talk of banning menthol cigarettes completely with California and Massachusetts already introducing state bans, and given the dominant position of BATS' Newport Brand, this would be an unwelcome blow. California's ban also includes fruity vapes, and further bans of this sort could dent BATS growth ambitions for its new products.
The major question facing the group, and the whole industry, is how it can attract and retain consumers who are becoming ever more health conscious. That's why BATS has decided to spend big on New Categories like e-vapour and heated tobacco. Growth's been impressive and having three strong, market leading, brands give an edge over competition. The division is loss making, but those are reining in and profits are expected to start in 2025.
A valuation of 8.4 times future earnings is significantly below its longer-term average. Though any major re-rate seems unlikely for now while regulatory risks loom and the core business is ultimately propped up by an industry in decline. The other important thing to consider with tobacco stocks is that many institutional investors can't, or won't, invest in the sector. This may mean that the shares are rated lower than the outlook for the industry really warrants, but it's hard to see attitudes changing.
However, for investors that are prepared to accept some extra risk and have faith that products like vape and heated tobacco can scale to levels similar to traditional tobacco products, BATS is one of the more exciting names. As ever, please remember nothing is guaranteed and investments can go down as well as up in value.
BATS key facts
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.
This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. It was correct as at the date of publication, and our views may have changed since then. 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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