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British American Tobacco - New Categories drive growth

First half revenue grew 3.7%, excluding the impact of exchange rates, to £12.9bn.

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British American Tobacco's first half revenue grew 3.7%, excluding the impact of exchange rates, to £12.9bn. That was largely driven by strong growth in New Categories, whilst traditional combustibles were broadly flat.

Underlying operating profit rose 4.9%, excluding the impact of exchange rates, to £5.5bn as losses reduced in New Categories and cost savings kicked in.

The group's on track for full year guidance, with constant currency revenue growth of 2-4% and progress toward £5bn New Category revenue by 2025.

The shares were broadly flat following the announcement.

View the latest BATS share price and how to deal

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 £27bn 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. 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. 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. 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.

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 9.1 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.

Half Year Results (underlying and ignoring the effect of exchange rates)

New Category revenue increased across all product ranges, with total sales up 45.4% to £1.3bn. Combustibles, including cigarettes, saw sales grow 0.6% as higher prices offset volumes that fell 4.2%.

In the US, revenue was broadly flat as growth in New Categories and Non-Combustibles was offset by declines in Combustibles, where volumes fell 13.4%. Vuse was the standout product, with revenue growth of 60%, now the market leader. Operating profit rose 5.5% to £2.9bn, driven by cost savings.

Asia Pacific and Middle East saw revenue grow 4.7% to £2.2bn. That was driven by volume growth in Combustibles and strong performance from all three New Category product ranges. Heated tobacco, the main New Category product in the region, saw sales rise 15.6% and the Glo brand performed well in Japan. Operating profit fell 5.4% to £821m, partly due to a higher portion of sales coming from lower margin products.

In the Americas and Sub-Sahara Africa revenue rose 6.0% to £1.9bn thanks to growth across both Vapour and Combustibles. Operating profit rose 6.5% to £754m. It was a similar story in Europe, where revenues rose 9.7% to £3.0bn. Operating profit rose 11.7% to £997m, driven by higher revenue and cost management. The division recognised £957m of impairment charges relating to the planned disposal of its Russian business.

Free cash flow increased from £1.3bn to £2.3bn, largely driven by an increase in operating cash flow. Net debt fell from £41.3bn to £40.8bn.

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.

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.

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Article history
Published: 27th July 2022