British American Tobacco Plc

British American Tobacco Plc (LON: BATS) is an FTSE 100 index listed holding Company founded in 1902 and headquartered in London, the United Kingdom. With operations spanned globally, the Company provides tobacco and nicotine products to consumers.

Investment Rationale for Valuation – Buy at GBX 2,758.50

• The Company is transforming into high growth, diversified consumer goods business. It also strives to reduce negative health impact on the consumers. Hence, it would meet changing needs of the customers who are becoming more health-conscious.
• £1.4 billion of revenues in FY2020 came from reduced-risk new category products. It signifies the continuously evolving and diversified nature of the business.
• To drive faster decision making, the Company adopted an organisational simplification programme. It could help the Company adapt faster to market trends.
• The Company wants to offer dividends with a payout ratio of 65%. Hence, the management has high confidence in Company’s operations and financials. It also sends a positive signal to the shareholders.
• On the profitability front, since FY2013, the operating margin and net margin of BATS consistently remained significantly higher than the industry median of 17.7% and 8.5%, respectively, illustrating the consistent good top-line generation and better management of expenses as compared to the industry.
• On the technical front, the 20-day EMA (GBX 2,734.00) is currently lower than the stock price, which indicates the upside potential of the stock price.

Key Risks

• Operational challenges are pertinent to disruptive factors caused by the Covid pandemic.
• The Company is exposed to health-related risks. However, it is strategically trying to diversify and reduce this health impact.
• The Company is also subject to regulatory norms and higher taxes related to tobacco sales.
• Tobacco also has a social aspect as people are getting more socially conscious and trying to get away from tobacco products.
• Its high dividend payout ratio could put stress on its liquidity.

AGM Statement (released on 28 April 2021)

• Driven by the strength and diversity of the business, BATS delivered a strong operational performance in FY2020. It enabled the Company to achieve constant currency revenue growth of ~3.3% YoY, exceeding the 1% to 3% guidance range.
• Driven by its cost-savings measures, the Company achieved higher growth in profitability than its top line. Its operating profit was up ~4.8% YoY while its diluted EPS rose ~5.5% YoY. Due to this, the operating margin also grew by 100 basis points.
• The Company has the commitment to maximise cash to reduce leverage. Hence, it achieved an adjusted operating cash conversion of 103% in FY2020, which increased its liquidity position.
• Despite the challenging environment, the management maintained a 65% dividend payout ratio driven by its strong balance sheet and solid liquidity position.

One Year Share Price Chart

(Source: Refinitiv, Thomson Reuters)

Valuation Methodology: Price/Earnings Approach (NTM) (Illustrative)

Conclusion

Even in the face of Covid-19 induced headwinds, the Company has seen solid performance across its reduced-risk New Categories businesses. The management is confident of achieving its £5 billion revenue target by FY2025. The Company is planning substantial investments in New Categories and expanding to new markets. The management is confident of constant currency revenue growth in the range of 3% to 5% and mid-single-digit adjusted EPS growth. Also, the board aims to deleverage the balance sheet by significant cash conversion, increasing financial flexibility. The tobacco industry as a whole is diversifying to lower-risk products to cater to health-conscious consumers. The stock made a 52-week low and high of GBX 2,423.00 and GBX 3,309.00, respectively.

Based on the above factors and support from valuation as done using the above method, we have given a “BUY” recommendation on British American Tobacco Plc at the current market price of GBX 2,758.50 (as on 6 May 2021 at 10.30 AM GMT), with a lower double-digit upside potential based on 9.63x Price/NTM Earnings (approx.) on FY21E earnings per share (approx.).

Phoenix Group Holdings Plc

Phoenix Group Holdings Plc (LON: PHNX) is an FTSE 100 index listed insurance Company founded in 1782 and headquartered in London, the United Kingdom. The Company is the largest life and pension consolidator in Europe. The Company operates under three segments: UK Heritage, UK Open and Europe.

Investment Rationale for Valuation – Buy at GBX 727.28

• Phoenix had delivered a resilient business performance in FY2020 and would carry the positive momentum in FY2021.
• The Company has market-leading capabilities, and it responds to changing pension’s landscape to achieve future growth.
• The acquisition of the Standard Life brand would enable the Company to provide a multi-channel consumer experience and more broad-based products and services.
• PHNX completed the acquisition of ReAssure to become the UK’s largest saving and retirement business.
• During FY2020, PHNX delivered a record cash generation of ~£1.7 billion, which is more than the forecast of £1.5 to £1.6 billion.
• In the last year, the Company delivered a return that is higher than its benchmark FTSE 100 index return, ie the stock outperformed the index. It could be a positive signal to the shareholders.
• On the technical front, the 20-day EMA (GBX 724.98) is currently lower than the stock price which reflects uptick in the stock price could be visible in the near term.

Key Risks

• The Company should maintain substantial capital adequacy and liquidity to meet the claims requirement.
• The Company’s performance is subject to certain risks such as market prices of assets and the condition of credit markets.
• Major sovereign debt event and corporate sector failures could affect the value of bond portfolios.

Financial Highlights (for the year ended 31 December 2020 (FY2020), as on 8 March 2021)

(Source: LSE Website)

• The Company achieved resilient operating performance in FY2020. Driven by that performance and the Company’s efficient cash conversion, it achieved record cash generation of ~£1.7 billion.
• It also helped the Company in achieving a long term free cash flow of £13.4 billion in FY2020. It could help in deleveraging going forward.
• The cash accretion helped the Company to deleverage in FY2020. Hence, it could achieve a leverage ratio of 28% in FY2020, which is within the 25% to 30% target range.
• Driven by a solid balance sheet and strong liquidity, the Company recommended a final dividend of GBX 24.1 per share, up 3% on the latest 2020 interim dividend.

One Year Share Price Chart

(Source: Refinitiv, Thomson Reuters) 

Valuation Methodology: Price/Earnings Approach (NTM) (Illustrative)

Conclusion

The Company is well-positioned to optimise its market-leading share in the UK long-term savings and retirement market. Phoenix's differentiated operating model signifies the whole being greater than the sum of the parts, exceeding its own and market expectations. The acquisition of the Standard Life brand will help diversify its offerings. PHNX is on track to deliver 100% renewable energy contracts across all offices by FY2021. There is a trend among people to invest more in insurance products. Also, the insurance sector would benefit from rising disposable income in the longer term. Hence, the Company is well-positioned to grow in the medium and long run. The stock made a 52-week low and high of GBX 551.00 and GBX 824.40, respectively.

Based on the above factors and support from valuation as done using the above method, we have given a “BUY” recommendation on Phoenix Group Holdings Plc at the current market price of GBX 727.28 (as on 6 May 2021 at 10.45 AM GMT), with a lower double-digit upside potential based on 10.12x Price/NTM Earnings (approx.) on FY21E earnings per share (approx.).

*Dividend Yield may vary as per the stock price movement.

*All forecasted figures and Peer information have been taken from Refinitiv, Thomson Reuters.

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