British American Tobacco Plc – Delivered decent results in a challenging year

British American Tobacco Plc (LON: BATS) is the FTSE 100 listed global holding Company, which deals in tobacco and nicotine products.

On 28 April 2021, the Company will hold its Annual General Meeting.

Rationale for Valuation – Buy at GBX 2,537.00

• As per valuation metrics, EV/Sales, EV/EBITDA, Price/Earnings and Price/Cash Flow multiples of the British American Tobacco Plc are currently lower as compared to the corresponding multiples of the Food & Tobacco industry. It reflects, shares are undervalued as compared to the industry.
• The Company expects 2021 revenue growth on a constant exchange rate to be in the range of 3% to 5%, along with Mid-Single growth in adjusted diluted EPS on a constant exchange rate.
• The Company has decent fundamental metrics as it has maintained a net margin above 20% for the last three years.
• From the technical standpoint, 14-day RSI is currently supports an upside move (around 40.37 level), which means the stock price could increase in the short term.

Key Risks

• The Company is exposed to health-related risks, and it is putting strenuous efforts through its strategy to reduce the health impact on the business.
• BATS is also exposed to regulatory norms and higher taxes related to tobacco sales.
• It is cognizant that combustible products pose a significant health risk, and thus, from a social aspect, it states that the only way to avoid these risks is not to start or quit.

Financial Highlights (for the year ended 31 December 2020 (FY20), as on 17 February 2021)

(Source: Company Website)

• The reported revenue was down by 0.4% YoY, while adjusted revenue increased by 3.3% YoY. Led by an increase in the Strategic portfolio, the Cigarette value share was up by 20 bps.
• On a reported basis, the profit from operations increased by 10.5% YoY, with an increase in an operating margin of 380 bps, driven by an improvement in the Group's operating performance.
• With high cash, the Company has a strong liquidity profile, achieved operating cash flow conversion of more than 95%, and successfully raised £8.9 billion in new debt.
• The Board has declared a full-year dividend per share of 215.6 pence, an increase of 2.5% YoY.

One Year Share Price Chart

 (Source: Refinitiv, chart created by Kalkine Group)

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

Conclusion

The Company is aiming to deleverage its balance sheet by bringing down net debt/adjusted EBITDA to around 3x by the end of 2021. BATS has anticipated a dividend pay-out ratio of 65% of adjusted diluted EPS well-supported by a strong liquidity position. Moreover, British American Tobacco has set a medium-term rating target of BBB+/Baa1, with a current rating of BBB+/Baa2. On a constant currency basis, the 2021 revenue is expected to be in the range of 3%-5%, with a new categories revenue target of £5 billion in 2025. It also expects an operating cashflow conversion to be more than 90% in 2021. However, the Global tobacco industry showing a downtrend in 2021 and expected to be down by around 3%, due to Covid-19 uncertainties. The stock made a 52-week low and high of GBX 2,362.50 and GBX 3,308.50, respectively.

Based on the decent growth prospects, and support from the valuation as done using the above method, we have given a “BUY” recommendation on British American Tobacco Plc at the current price of GBX 2,537.00 (as on 2 March 2021, before the market close at 8:00 AM GMT), with lower double-digit upside potential based on 9.18x Price/NTM Earnings (approx.) on FY21E earnings per share (approx.).

Imperial Brands Plc – Operating with strong tobacco volumes

Imperial Brands Plc (LON: IMB) is a FTSE-100 listed company, which is engaged in providing consumer goods. It has two broad business segments: Tobacco and NGP (Next Generation Products).

Rationale for Valuation – Buy at GBX 1,369.66

• The five-year (FY20-25) transform plan expects net revenue to grow around CAGR 1%-2%.
• From the period FY18 to FY20, EBITDA margin and operating margin have remained above 11% and 7%, respectively, reflecting a decent operational performance.
• As per valuation metrics, EV/EBITDA, Price/Earnings and Price/Cash Flow multiples of the Imperial Brands Plc are currently lower as compared to the corresponding multiples of the Food & Tobacco industry. It reflects, shares are undervalued as compared to the industry.
• From the technical standpoint, 14-day RSI is currently supports an upside move (around 36.08 level), which means the stock price could increase in the short term.

Key Risks

• The performance can be impacted with ongoing Covid-19 challenges which can disturb the cash collection, operational delivery, and transform the consumer behaviour.
• The business is also exposed to the risks pertinent to the failure of new product development, unfavourable price outcome, credit rating downgrades, interest rate fluctuations, lower inflation, and competition in the tobacco market.

Recent Developments

On 17 February 2021, the Company announced the appointment of Lukas Paravicini, as a Chief Financial Officer, which will be effective from 5 August 2021. Lukas succeeds Oliver Tant.

Financial Highlights (for the year ended 30 September 2020 (FY20), as on 17 November 2020)

(Source: Company Website)

• Despite the challenging year with a poor NGP performance and some disruption from the Covid-19 pandemic, the Company delivered strong Tobacco volumes, with better market size and share trends in several markets.
• During FY20, the revenue surged 0.8%, while the Tobacco volume declined by 2.1%. The Company has bolstered its Executive Team to support its growth.
• On a constant currency basis, the adjusted earnings per share decreased by 5.6% year-on-year in FY20. The reported earnings per share increased by 49.4%.
• The Company has a strong underlying cash performance with a decrease in net debt.
• It has proposed a final dividend per share of 48.01 pence, bringing the 2020 total dividend per share of 137.71 pence.

One Year Share Price Chart

 (Source: Refinitiv, chart created by Kalkine Group)

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

Conclusion

In FY21, the Company expects to deliver low to mid-single-digit growth in organic adjusted operating profit at constant currency. On 30 September 2020, the Company was rated Baa3, with a stable outlook by Moody's Investors Service Ltd. It was also rated BBB/A-2, with a stable outlook by Standard and Poor's Credit Market Services Europe Limited. Further, Tobacco pricing is expected to remain strong, with constant currency IMB earnings per share expected to be slightly ahead of the previous year.

Moreover, in FY21, the Company’s outlook remains in line with previous expectations. The five-year transform plan also expects net revenue to grow around CAGR 1%-2% over the five years (FY20 to FY25). According to the first two years of the plan, the Company expects organic operating profit to be flat in FY22 at constant currencies as compared to FY21. Further, over the three-years (FY23 to FY25), the adjusted operating profit is expected to deliver a mid-single-digit organic CAGR. The stock made a 52-week low and high of GBX 1,203.00 and GBX 1,758.00, respectively.

Based on the decent growth prospects, and support from the valuation as done using the above method, we have given a “BUY” recommendation on Imperial Brands Plc at the current price of GBX 1,369.66 (as on 2 March 2021, before the market close at 8:02 AM GMT), with lower double-digit upside potential based on 6.54x Price/NTM Earnings (approx.) on FY21E earnings per share (approx.). 

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

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

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