British American Tobacco PLC (LON: BATS) – Multi-category strategy is delivering growth in difficult times.

British American Tobacco PLC (BATS) is a FTSE-100 listed Consumer Goods Company, which serves consumers with tobacco and nicotine products around the world. Its non-combustible portfolio includes Velo and Grizzly, Vuse and Vype, Camel Snus, and glo™. It also includes a portfolio of combustible products, such as combustible, Newport, Dunhill Tobacco, Rothmans, Camel, Pall mall, among others. The Company was established in 1902, and presently, it is one of the world's leading, multi-category Consumer Goods Companies. As of 31 December 2019, it employed over 53,000 people to serve millions of people in over 50 countries.

While the Company continues to recognise the importance of its conventional cigarette brands, it has also been increasingly providing a range of potentially reduced-risk tobacco and nicotine products, which have been established as a portfolio of priority brands – Strategic Portfolio. The growing portfolio of potentially reduced-risk products includes snus and moist snuff, tobacco-free nicotine pouches, modern oral products, tobacco heating products and vapour.

In December 2020, the Company expects to release the pre-closing trading update.

   (Source: Presentation, Company Website)

Industry Outlook Dynamics

According to the report from Grand View Research, the market size for global tobacco market is expected to grow at a CAGR of 3.1% from 2019 to 2027. It was valued at US$849.09 billion in 2019 and projected to reach the size of US$1,083.16 billion by 2027.

The market is gaining momentum, and the market growth is fuelled by the rising consumer disposable income, new product launches, availability of superior-quality products, and increasing consumption among females and students. In 2019, Cigarettes led the global tobacco market and contributed over 70.00% share of the global revenue. Meanwhile, the next-generation products are expected to grow at a CAGR of 10.7% from 2020 to 2027.

Growth Prospects and Risk Assessment

The Company is working towards a better tomorrow as 10% of H1 FY20 revenues generated from non-combustible categories, and it is targeting 50 million non-combustibles consumers by 2030. In order to achieve that, it has invested £250 million in New Categories marketing. Moreover, multi-category consumer acquisition shall drive the share growth. Therefore, the Company remained on track to deliver against FY20 guidance. It continued to maintain investment-grade credit ratings with ratings from S&P/Moody’s at BBB+ (stable outlook)/Baa2 (stable outlook), respectively. Furthermore, it is targeting the carbon neutrality by 2030 and accelerating existing environmental targets to 2025.

(Source: Refinitiv, chart created by Kalkine Group)

Also, the board had declared an interim dividend per share of 210.4 pence, which is payable in four equal quarterly instalments of 52.6 pence in May 2020, August 2020, November 2020 and February 2021.

However, the global travel retail is expected to be substantially impacted for the remainder of FY20. The share of income from associates (especially ITC India) is anticipated to reflect the Covid-19 impact. Meanwhile, the foreign exchange fluctuations are likely to impact 2.5% on full year adjusted EPS growth. Similarly, the socio-economic impact of the pandemic, increased risk of regulation, excise increases, and supply chain disruption are also likely to impact business growth.

Key Fundamental Statistics

Key Shareholders Statistics

Key Performance Indicators (H1 FY20)

 (Source: Company Website)

Business Segments (from continuing operations)

(Source: Company Website)

Financial Highlights (for the six months ended 30 June 2020 (H1 FY20), as on 31 July 2020)

 (Source: Company Website)

• British American Tobacco highlighted that the sales volume of global cigarette and tobacco heating product to remain passive in 2020.
• In H1 FY20, the Company’s revenue surged by 2.4% year-on-year (on a constant currency basis).
• The combustible revenue and the new category revenue was up by 2.2% and 12.7%, respectively.
• The cigarettes price mix surged by 8.5% year-on-year that lowered the negative effect of 6.3% in sales volume of cigarette and tobacco heating products.
• Based on the regional performance, the adjusted revenue from the US and ENA (Europe & North Africa) regions increased by 9.7% and 3% year-on-year, respectively, whereas AMSSA (Americas & Sub-Saharan Africa) and APME (the Asia Pacific & Middle East) revenue declined by 0.9% and 10.5% year-on-year, respectively.
• The operating margin improved from 42.9% in H1 FY19 to 43.7% in H1 FY20, following a 4% positive impact of pricing and operational efficiencies, whereas negative impact was due to incremental new categories and translational foreign exchange.
• Reported basic and diluted earnings per share increased by 22.7% to 151.2 pence and 150.7 pence, respectively.
• Led by the bond issuances in H1 FY20 and weakness in a foreign exchange transaction, the borrowings increased to £50,461 million as compared with the previous period (31 December 2019: £45,366 million).
• Net cash generated from operating activities surged by 52% year-on-year, mainly driven by the deferral of total excise and corporate tax payments.
• Strategic Cigarette and THP (Tobacco Heating Product) volume decreased by 3.4%, with an increase in value share of 40 bps and volume share of 30 bps. It also witnessed a growth in all the regions.
• The Company expects the revenue to grow between 1% and 3% in FY20 with earnings per share growth in the mid-single-digit.
• It also anticipates the operating cash conversion to be more than 90% in 2020.
• In the new category revenue, BATS has a target of £5 billion for 2025.

Financial Ratios - Strong Profitability Margins versus the Industry Median

Reported profitability metrics for the first half of 2020 were higher against the industry median, reflecting higher revenue generated and better control over expenses as compared to the industry. Also, it has decent fundamental metrics as it has maintained an EBITDA and Operating margin above 30% from the last three years. ROE stood at 5.2% in H1 FY20, an increase from the corresponding period of the last year. On the liquidity front, BATS’s current ratio was lower than the industry median, but the Group has sufficient current assets to pay the short-term obligations. On leverage front, the debt-equity ratio was 0.73x, which was higher as compared to the industry median of 0.31x, reflecting that the Company is more leveraged as compared to the industry.

Share Price Performance Analysis

(Source: Refinitiv, chart created by Kalkine Group)

On 5 October 2020, at the time of writing (before the market close, at 8:27 AM GMT+1), British American Tobacco Plc shares were trading at GBX 2,772.77, up by 0.73% against the previous day closing price. Stock 52 week High and Low were GBX 3,507.00 and GBX 2,362.50, respectively.,

From the technical standpoint, the shares were trading above the short-term support level of 20 and 50-day simple moving average price. Also, the 90-day RSI is supporting the upside movement.

(Source: Refinitiv, chart created by Kalkine Group)

Valuation Methodology: EV/Sales Approach (NTM) (Illustrative)

(Source: Refinitiv, chart created by Kalkine Group)

Business Outlook Scenario

BATS remained financially robust and reiterated the commitment regarding dividend policy of 65% adjusted diluted EPS, which demonstrated confidence to navigate Covid-19 challenges. In FY20, the Company expects constant currency adjusted revenue growth between 1% to 3% with mid-single figure constant currency adjusted diluted EPS growth. Further, it is targeting to have £5 billion New Category revenue by FY25. The operating cash flow conversion is likely to stay above 90% in FY20. From an investment-grade credit rating perspective, the Company is expecting a medium-term target of Baa1/BBB+ from Moody’s/S&P, respectively. In order to mitigate the risk of interest rates, it maintains both floating-rate and fixed-rate debt. Furthermore, it is expecting to deleverage its adjusted Net debt/Adjusted EBITDA to 3x by FY21 end and targeting £1 billion of Quantum savings between FY20 to FY22.

Adjacently, the global cigarette and THP (Tobacco Heating Products) industry volume is expected to decline by around 7% in FY20. Meanwhile, the UK industry volume is projected to be de down by nearly 2.5% in FY20 (previously ~4.0%) as the consumer demand and higher stock level shall provide resilience. 

(Source: Presentation, Company Website)

Considering the good fundamental performance in H1 FY20, robust liquidity position, decent business growth rate trajectory, sound business model and support from the valuation as done using the above method, we have given a “Buy” recommendation on British American Tobacco at the current market price of GBX 2,772.77 (as on 5 October 2020, before the market close at 8:27 AM GMT+1) with lower double-digit upside potential based on 4.62x EV/NTM Sales (approx.) on FY20E sales (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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