British American Tobacco plc (BATS) Ordinary 25p
HL comment (11 February 2022)
British American Tobacco's (BATS) underlying full year revenue was £25.7bn, up 6.9% ignoring the effect of exchange rates. This reflects a 50.9% increase in increase in New Categories revenue to £2.0bn, while traditional Combustibles rose 4% to £23.7bn. Underlying operating profit rose 5.2% to £11.2bn.
BATS expects to deliver £5bn of revenue and profitability from New Categories by 2025.
A £2bn share buyback scheme has been announced, as well as an interim dividend of 217.8p per share.
The shares were unmoved 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.
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 held up well during the coronavirus pandemic, and is now normalising.
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 the US, 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 the group expects them to start turning a profit in 2025.
A valuation of 9.1 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
- Price/Earnings ratio (next 12 months): 9.1
- 10 year average Price/Earnings ratio: 13.2
- Prospective dividend yield (next 12 months): 7.1%
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 currency)
Overall Combustibles revenue increased, driven by price rises, with volumes falling 7%.
US revenue rose 9.2% to £12.5bn, with a 53.3% increase in New Categories, including vaping products. Combustible revenue rose 8.1% to £10.7bn, driven by pricing. 70bn cigarettes were sold, representing a 5% volume decline. Operating profits rose 9.7% to £6.3bn.
Asia Pacific and Middle East saw Modern Oral revenue, which includes tobacco-free nicotine pouches and traditional snuff, almost triple. That fed into a 14.2% increase in New Categories revenue to £588m. Total Combustible revenues fell 2.3% to £3.8bn because of a less lucrative mix of geographic sales and competitive pricing in Australasia. Operating profit fell 1.1% to £1.8bn.
In the Americas and Sub-Sahara Africa revenue rose 7.8% to £4.1bn thanks to growth across both product types. Operating profit rose 4.3% to £1.7bn. It was a similar story in Europe and North Africa, where revenues rose 7.3% to £6.4bn, although profit dipped 1% because of ongoing investment in New Categories.
Free cash flow after dividend payments was £2.5bn, broadly flat compared to last year. Net debt fell almost 10% to £35.5bn.
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 disclosure for more information.
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