Overview
British American Tobacco PLC (BATS) is a London, United Kingdom-headquartered one of the leading, multi-category consumer goods companies in the world with core business around tobacco, which seeks to provide consumers with high-quality tobacco products. The company was established in 1902, following a joint venture between the American Tobacco Company of the United States and Imperial Tobacco Company of the UK, and rapid expansion helped the group to establish a dominant position in various international markets. Today, the company employees 55,000 personnel around the world and is a market leader in more than 55 countries. Many of the world-famous brands include Rothmans, Pall Mall, Kent, Dunhill, and Lucky Strike, which operate in over 200 markets.

While the company continues to recognise the continued importance of its conventional cigarette brands to its business, the company has been increasingly giving more priority to providing its consumers with a range of potentially reduced-risk tobacco and nicotine products, which have been established as a portfolio of priority brands – Strategic Portfolio. The company would continue investing in developing and commercialising potentially reduced-risk products, and this would enable it to continue to deliver growth in its traditional tobacco business. The growing portfolio of potentially reduced-risk products includes traditional oral products such as snus and moist snuff, tobacco-free nicotine pouches, modern oral products, tobacco heating products and vapour.

Key Statistics



Management

Richard Burrows is the Chairman of the Board of the company since November 2009. On 1 April 2019, Jack Bowles was appointed as the Chief Executive Officer of the company. The CEO is assisted by Tadeu Marroco, who is the Finance Director of the company.

Segments

The company is organised and managed on the basis of its geographic regions, with segments being United States, Asia-Pacific and Middle East region (APME), Americas and Sub-Saharan Africa region (AMSSA), and the Europe and North Africa region (ENA). After the acquisition of Reynolds American Inc, the results from the company were merged in the United States segment. Company's Next Generation Products' segment is not considered as a reportable segment that requires separate disclosure as the same is not currently material and this is reported as part of the results of each geographic region, though the company differs amongst its product offering between tobacco and Next Generation Products.

Top Shareholders

 
(Source: Thomson Reuters)

Recent Development

The company on 12 September 2019 announced its proposal to simplify the group to drive New Category growth, which would create a more efficient, agile and focused organisational structure by ensuring the elimination of duplicative activities, greater management accountability, faster decision making and focus on key growth areas. The proposal includes efforts to better leverage its Global Business Services activities, create fewer larger more accountable business units and reduce management layers, which would help in delivering savings that can be reinvested in the growth of its portfolio of new categories such as vapour, tobacco heating products and oral tobacco. The company reported that over 20% of the senior roles in the organisation would be affected, due to the focus on simplification and removal of management layers, and the programme which is expected to be completed by 2020 and includes reduction of around 2,300 roles globally.

Financial Highlights (H1 2019, in £m)


 (Source: Company Filings)

As a decline in total cigarettes and Tobacco Heating Products (THP) volume of 3.5% was more than offset by a translational foreign exchange tailwind of 1.2%, the growth of New Categories and Traditional Oral and good price/mix (totalling 7%) across the cigarette portfolio. On a reported basis, revenue increased by 4.6% to £12,170 million. Adjusted revenue increased by 4.1% at constant rates of exchange, which excludes the effect of excise on bought-in goods and the foreign exchange tailwind. Driven by the continued growth of Rothmans and success of Neo, Strategic Cigarette and THP increased volume share by 60 bps, and total cigarette and THP volume declined in line with the industry, while value share increased by 10 bps in key markets. Driven by growth in revenue from New Categories and Traditional Oral and robust cigarette pricing, which included a reduction in discounting in the US, revenue from the Strategic Portfolio increased by 8.7% to £8,835 million, or 6.6% on an adjusted constant rate basis. Revenue from Tobacco Heating Products increased by 8.5% to £313 million, or 4% at constant rates of exchange, as consumable volume grew by 17% to 3.9 billion sticks during the period (30 June 2018: 3.3 billion sticks), indicating that the group continued to deliver significant growth in THPs during the first half of 2019. Revenue from Vapour portfolio was up by 63% to £189 million (30 June 2018: £116 million) or 58% at constant rates of exchange as volume of vapour consumables was up by 32% to 102 million units during the period (30 June 2018: 78 million units), suggesting that the portfolio continued to perform strongly. Due to the impact of the charge worth £436 million in respect of the Quebec Class Action, which more than offset improvement in the operating performance, profit from operations was down by 1.3% by on a reported basis to £4,380 million, with operating margin declined by 210 bps to 36.0%. As adjusted profit from operations increased in all regions, especially in the US, which rose by over 11%, adjusted profit from operations at constant rates of exchange was 5.9% higher at £5,103 million. Reflecting continued drive for efficiency gains, which included the product rationalisation to remove complexity, adjusted operating margin, at current rates, was 110 bps higher than the same period in 2018 at 42.9%. Profit before taxation was reported at £3,865 million during the period against £3,969 million in the prior year, while profit after tax increased from £2,776 million in H1 2018 to £2,894 million during the current period. Driven by an improved performance from the main associate of the group (ITC), the reduction in the effective tax rate from 30.1% to 25.1% and the higher profit from operations (before the impact of the Quebec charge), adjusted diluted earnings per share grew by 8.8% to 149.3p (30 June 2018: 137.2p), and basic earnings per share were 4.6% higher at 123.2p (30 June 2018: 117.7p). Due to free cash outflow (after dividends paid to shareholders) of £1,052 million (30 June 2018: £611 million inflow), adjusted net debt rose to £45,532 million (30 June 2018: £44,739 million) and borrowings increased to £50,292 million (30 June 2018: £48,512 million).

Segmental Analysis
 
 
(Source: Company Filings)

In the United States, total value share increased by 30 bps, with a  volume share of the premium market was up 40 bps, while cigarette volume declined by 6.0% to 36.2 billion sticks, largely due to industry contraction. Reflecting higher revenue from both vapour (driven by growth of Alto) and Traditional Ora, and a reduction in discounting, leading to a price/mix on cigarettes increase of over 8%, reported revenue increased by 10.2% to £4,989 million, while reported profit from operations increased by 19.9% to £2,249 million.

In the Asia-Pacific and Middle East region, cigarette and THP volume was 2.3% lower than the same period in 2018 at 113.3 billion sticks and reported revenue grew by 0.9% to £2,405 million, with a growth of 1.6% on a constant currency basis. Driven by Japan (largely due to the performance of THP) and Saudi Arabia (driven by pricing and volume), reported profit from operations increased by 2.1% to £940 million, and adjusted profit from operations grew by 4.6% to £995 million, at constant rates of exchange.

In Americas and Sub-Saharan Africa region, cigarette and THP volume was 3.5% lower at 74.4 billion sticks, and revenue grew by 3.3% to £2,015 million, with a growth of 7.5% to £2,098 million on a constant currency basis. Due to the £436 million charge in relation to Quebec, reported profit from operations was down by 59% to £328 million. Driven by higher profit from operations in Nigeria and Canada, adjusted profit from operations on a constant currency basis grew by 0.8% to £835 million, which excluded the effect of currency and adjusting items.

In the Europe and North Africa region, due to lower volume in Russia, Ukraine, Egypt and Germany, cigarette and THP volume declined by 4.0% to 112.1 billion sticks, and reported revenue declined by 0.5% to £2,761 million, though the company reported an increase of 4.6% to £2,795 million at constant rates. Reported profit from operations grew by 1.9% to £863 million, while adjusted profit from operations grew by 0.1% over the year at constant rates to £950 million.

Financial Ratios

 
(Source: Thomson Reuters)

The profitability margins of the group have been improving over the years and were higher than the last year. However, the net margin has been under pressure and declined over the previous year. The liquidity ratios have also declined gradually, which might indicate a normalisation of ratios. However, the company has considerably improved on its leverage and is now significantly less leveraged, with the leverage ratio declining marginally over the last year. On asset turnover ratio front, the group has space to utilise its assets better.

Valuation Methodology
Method 1:EV/EBITDA Multiple Approach (NTM)



To compare BATS with its peers, EV/EBITDA multiple has been used. The peers are Imperial Brands PLC(NTM EV/EBITDA was 7.25), Japan Tobacco Inc(NTM EV/EBITDA was 8.22), Altria Group Inc(NTM EV/EBITDA was 9.94),and Philip Morris International Inc(NTM EV/EBITDA was 11.43) The median of EV/EBITDA (NTM) of the company’s peers was 9.08x (approx.).

Method 2: EV/Sales Multiple Approach (NTM)
  


To compare BATS with its peers, EV/Sales multiple has been used. The peers are Imperial Brands PLC(NTM EV/Sales was 3.35), Nestle SA(NTM EV/Sales was 3.64),Reckitt Benckiser Group PLC(NTM EV/Sales was 3.93), Anheuser Busch Inbev NV(NTM EV/Sales was 4.82), Philip Morris International Inc(NTM EV/Sales was 4.92), and Swedish Match AB(NTM EV/Sales was 5.01). The mean of EV/Sales (NTM) of the company’s peers was 4.28x (approx.).

Share Price Commentary

 
Daily Chart as at 21-October-19, before the market closed (Source: Thomson Reuters)

On 21 October 2019, at the time of writing (before the market closed, at 12:30 pm GMT), BATS shares were trading at GBX 2,655.29, down by 0.30 per cent against the previous day closing price. Stock's 52 weeks High and Low are GBX 3,659.00/GBX 2,249.00. The company's stock beta was 1.44,reflecting more volatility as compared to the benchmark index. The outstanding market capitalisation was around £61.10 billion, with a dividend yield of 7.62 per cent.

Growth Prospects and Risks Assessment

The company intends to consolidate its New Category portfolio into fewer brands as it seeks to create a stronger, simpler business and focus on building global brands. While New Category growth in the second half is expected to be driven by a focus on priority markets and new product launches, Strategic Brands continue to grow. The company enjoys huge geographical diversity, helping it to avert political and economic instability in any one region. Keeping in mind recent developments, it is also diversifying its business into new products. The company believes it the latest push to simplify the organisational structure to drive New Category growth and would help the group to deliver on its target of £5 billion of revenues in New Categories by 2023/24, and reported that it was on track to be around in the middle of its guidance range of 30-50% New Categories revenue growth per annum.

The risk that the group would capitalise on the opportunities in developing and commercialising successful and consumer-appealing innovations, especially Potentially Reduced-Risk Product, would lead tofinancial loss in the future as the new companies and products would capture the market share. The company is exposed to unexpected and significant changes in the tobacco-related taxes in key markets, which may be exacerbated by the continuing difficult economic and regulatory environment in many countries, market contraction and consumer down-trading concerns.

Conclusion

The group has reported an impressive growth over the last five years, with revenue increasing at a CAGR of 12.35% and gross revenue up by a CAGR of 13.63%, indicating improved efficiency as well. Operating income rose at a CAGR of 12.2%, while net income increased at a CAGR of 10%. The new CEO looks determined to achieve the target of generating £5 billion of revenues in New Categories by 2023/24, and has taken several hard decisions in that respect, including removal of management layers and reduction of around 2,300 roles, which would drive efficiency.
 
Based on the decent prospects and supported by valuation done using the above two methods, we have given a “BUY” recommendation at the current price of GBX 2,652 (as on 21 October 2019, before the market closed) with high single-digit upside potential based on 9.08x NTM EV/EBITDA (approx.) on FY19E EBITDA (approx.) and 4.28x NTM EV/Sales (approx.) on FY19E Sales (approx.).
 
 
*All forecasted figures and Peer information have been taken from Thomson Reuters.

Disclaimer

PLEASE BE ADVISED THAT YOUR CONTINUED USE OF THIS SITE OR THE INFORMATION PROVIDED HEREIN SHALL INDICATE YOUR CONSENT AND AGREEMENT TO THESE TERMS.
References to ‘Kalkine’, ‘we’, ‘our’ and ‘us’ refer to Kalkine Limited.
This website is a service of Kalkine Limited. Kalkine Limited is a private limited company, incorporated in England and Wales with registration number 07903332.
The article has been prepared for informational purposes only and is not intended to be used as a complete source of information on any particular company. Kalkine is not responsible for material posted on this website and does not guarantee the content, accuracy, or use of the content in this site. No advice or information, whether oral or written, obtained by you from Kalkine or through or from the service shall create any warranty not expressly stated.
Kalkine do not offer financial advice based upon your personal financial situation or goals, and we shall NOT be held liable for any investment or trading losses you may incur by using the opinions expressed in our publications, market updates, news alerts and corporate profiles. Kalkine does not in any way endorse or recommend individuals, products or services that may be discussed on this site. You should discuss your portfolios and the risk tolerance level appropriate for your personal financial situation, with a professional licensed financial planner and adviser.