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RBC slashes target for British American Tobacco on outlook for menthol/NGPs

Thu 29 November 2018 08:16 | A A A

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(Sharecast News) - Analysts at RBC slashed their target price for shares of British American Tobacco from 3,400p to 2,700p, saying that the uncertainty around the outlook for its menthol cigarettes unit was casting a pall over the investment case for the company's shares.

However, the combined impact from the US regulator's ban on menthol cigarettes and from the expected erosion of its margins resulting from the uptake of Next Generation Products was now priced into the stock, the Canadian broker said, pointing to the shares' 40% underperformance relative to the European consumer staples space in 2018.

Hence, it upgraded its recommendation from 'underperform' to 'sector perform', even as it added that the future for British American Tobacco was "very opaque".

RBC used two methods to arrive at its valuation, an adjusted present value calculation and a sum-of-the-parts approach.

Under the former, the working assumption was that half of the company's sales from menthol cigarettes would go up in smoke by 2025, as well as 75% of its profits due to the under recovery of fixed costs and narrower margins on those sales which migrated to NGPs.

Reflecting their own uncertainty, they also bumped up their estimate for the company's cost of equity by 50 basis points, resulting in a target price of 2700p per share.

As an aside, RBC said the company's debt was not an important consideration as management could always resort to selling its ITC stake.

From an SOP standpoint, that target price was consistent with a 20% EV/EBITDA discount on its non-menthol business relative to rival Altria's, while the menthol operations were at a similar valuation.

In turn, the above meant that the remainder of BAT's business was trading on 8.5 times the company's EBITDA for 2019, which was a 10% discount to Imperial Brands and of 30% versus PMI.

"In light of the uncertainty around menthol, we don't think this is unreasonable."

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