Business Overview
British American Tobacco Plc is a London based cigarettes manufacturer and distributor, founded in 1902. The company serves millions of adult customers globally and is a leading multi-category provider of tobacco and nicotine products. Their key brands are Dunhill, Kent, Vype, Epok, Lucky Strike, Pall Mall, Vuse, Granit, Rothmans, Newport, Glo, Mocca, Camel Spirit, Chic, Grizzly, Camel Snus, Kodiak, Kool, Peter Stuyvesant, Carven A and State Express 555.  At geographical contribution standpoint, Group's 38.7% of total revenue came from the United States, 19.9% from APME, 16.7% from AMSSA, and 24.5% came from ENA, as per FY18 annual report. Its shares are listed on the London Stock Exchange (BATS), Johannesburg Stock Exchange (BTI) and the company have issues American Depository Shares (ADS) on the New York Stock Exchange (BTI).

Key Statistics

Recent Developments
On 1 March 2019, Quebec Court of Appeal in Montreal issued a judgement against one of British Tobacco subsidiary, Imperial Tobacco Canada Ltd (ITCAN). As a part of the judgement, ITCAN has to place around £436 million in the escrow account. On 28^th February 2019, Company reported its full-year FY18 final results for the period ended 31^st December 2018. On 28 February 2019, Company announced an interim cash dividend of gross US$ 0.67, which is going ex on October 3, 2019. On 11^th June 2018, Company announced to invest €880 million in Romanian factory by 2022.

Key Managerial Employees


Top Shareholders

 
Financial Performance – FY18 (£, in millions)

(Source: Company filings, LSE)

Financial Commentary
British American Tobacco Plc revenue grew by 25 per cent, led by volume growth from cigarettes and THP by 3.3 per cent, due to the inclusion of RAI as a wholly owned subsidiary of British American Tobacco, and pricing as well. Cigarettes and THP volume grew by 3.3 per cent in FY18. Profit from operation stood at £9,313 million, up by 45 per cent against its FY17 profit from the operation. In the financial year 2018, the company’s adjusted net debt to adjusted EBITDA stood at 4.x against 5.3x reported last year for the financial year 2017. It reflects BATS’s commitment towards deleveraging. For the financial year 2018, basic earnings per share plunged by 86 per cent and diluted EPS lowered by 86 per cent, during FY17 EPS was affected by a one-time gain realised from the acquisition of RAI and a deferred tax credit on account of the US tax reforms. In FY18 adjusted diluted earnings per share improved by 11.8 per cent on a constant currency basis on account of growth in operating performance and lower effective tax rates. Dividend per share stood at GBX 203 for FY18, up by 4 per cent against FY17 dividend per share. Company key brand Dunhill reported stronger performance in Indonesia, South Africa and Brazil but got offset by performance in South Korea and Saudi Arabia. Kent's market share increased by 50 basis points and volume grew by 1.7% during FY18, led by growth in Japan, Turkey, Brazil and Ukraine. Lucky Strike market share grew by 20 basis points, and volume grew by 1 per cent during FY18, led by growth in Indonesia, Japan, Colombia, Spain, France, Argentina, and Mexico. Rothmans market share increased by 110 basis points and volume grew by 19.7 per cent, led by Russia, Ukraine, Nigeria, Bulgaria, Poland, Brazil and Colombia.
 
On a representative basis (as if BAT had owned RAI and the other acquisitions, completed in 2017, from 1 January 2017)
Volume in cigarettes and THP grew by negative 3.5 per cent to 708 billion, the volume of the major markets declined by 2.7 per cent. Volume in Strategic cigarettes and THP increased by 5.8 per cent, supported by a 217 per cent growth in THP consumables to 7 billion sticks, as well as North American Spirit, Rothmans and Pall Mall also witnessed growth in the financial year 2018. Adjusted revenue at constant current rate grew by 3.5 per cent, led by a strong cigarette price mix (6%). THP and Vapour sales increased by 95% to £901 million at constant exchange rates. At constant exchange rates, adjusted revenue from Strategic Portfolio increased by 8.5 per cent, led by a 5.7 per cent growth in sales from the strategic inflammable brands and revenue from oral stood at £952 million, witnessed a growth of 11 per cent. During the year adjusted profit from operation increased by 4 per cent at constant exchange rates. Adjusted operating margin increased by 40 basis points at 42.6 per cent at constant exchange rates, due to investment in the development and roll out of PRRP was more than offset by good pricing and cost control.

Stock Performance – 1 Year

Daily Chart as at Mar-08-19, before the market close (Source: TR)

At the time of writing (as on 08^th Mar 2019) before the market close, shares of British American Tobacco Plc were quoting at GBX 3,062.00, declined by 15.0 points or decreased by 0.48% against its previous day closing price. During the last one-year shares of British Tobacco Plc registered a 52w high of GBX 4,339.0 and a 52w low of GBX 2,336.50 and at current market price shares were trading 29.4% lower against its 52w high and 31.0% above its 52w low. Stock's price performance was negative 26.74% on a one-year basis but increased 23.08% on a year-to-date basis (as at 08-Mar-2019). Group’s dividend yield of 6.60% is relatively very high against its peer group operating within the same line of business. Stock's Beta of 1.4 makes it high volatile against the benchmark index movement. Average 5-day daily volume of 4.9 million traded on the London Stock Exchange was 21.94% above the average 30-day daily volume of 4.14 million. At the current market price, shares were trading 11.2% above its 30days simple moving average, 15.77% above its 60days moving average and 7.22% below its 200days simple moving average. As the stock is in the uptrend, it could break its 200day simple moving average hurdle in near time. Company’s outstanding market capitalisation of £71.04 billion ranks it among the large-cap company and a giant player in the tobacco industry.
 
Financial Ratios and Valuation
Ratios


At margin front, British American Tobacco Plc performance was considerably higher compared with its peer's median performance, as company's EBITDA margin for FY18 stood at 43.6% which was 360bps higher than the EBITA margin of FY17 and sharply higher than the industry median. Company's global brand portfolio accompanied by volume growth across every segment helped the company to report this stellar EBITDA margin. It also indicates how efficient the management is at British Tobacco compared with the management of its peer group. The company has delivered consistently EBITDA margin above 40% since last 5 years, which shows the fundamental strength of the business. However, at liquidity standpoint in terms of Current ratio, company’s ability to cover its short-term liabilities is relatively lower than its peer, for FY18 Current ratio stood at 0.78 compared with the industry median of 1.65. At a leverage standpoint, the company is relatively high leveraged against its competitors, for FY18 Debt/Equity ratio stood at 0.73 compared with the industry median of 0.31. Also, at turnover ratio standpoint in terms of Asset Turnover ratio and Inventory turnover ratio, company stand at backfoot within its competition. Asset turnover ratio for FY18 stood at 6 compared with the industry median of 9.5 and the inventory turnover ratio for FY18 stood at 0.8 relatively very low compared with the industry median of 3.4.


Valuation Methodology

Valuation Method 1


Valuation Methodology 2 (Sales (FY19E) approximately)

While valuing British Tobacco Plc at NTM EV/EBITDA valuation, we have considered NTM EV/EBITDA of its peers who were Imperial Brands PLC, Philip Morris International Inc, Swedish Match AB, Altria Group Inc, and Danone SA and their NTM EV/EBITDA were 8.7x, 11x, 16.x, 10.2x, and 10.3x respectively.

Note: All forecasted figures and peers have been taken from Thomson Reuters.

Key Risks
Increasing competition from illegal trade, reduction in market size and consumer down-trading, geopolitical disputes, tax reforms & penalties, Foreign exchange risk and liquidity risk.

Growth Prospects
British American Tobacco has adequate resources to meet its financial and operating requirement without any disruption for another three years, growing brand penetration and increasing smokers headcount will drive future growth of the company.

Conclusion
British American Tobacco Plc has a strong business model and significant market share within the tobacco industry across the world, with strong fundamentals. At margin front, also company enjoys a competitive advantage compared with its peers. The company has consistently delivered an EBITDA margin above 40% which shows its management efficiency. Based on the strong fundamentals and the valuation done using the above two methods, we have given a BUY recommendation at the closing price of GBX 3,077 (as on 7th March 2019) with single-digit upside potentialbased on NTM Peers average EV/EBITDA of 11x on FY19E EBITDA and Industry median NTM EV/Sales of 4.7x on FY19E Sales.

*The buy recommendation is also valid for the current price as covered in the report as on (8th March 2019)

Note- GBp or GBX are interchangeably used for Pence Sterling. 

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