British American Tobacco shares approach major level

After a quick rally, a thrust above this key price level is hugely significant for BAT shares. 

British American Tobacco (LSE:BATS) is on course for a significantly better year, after an exceptionally difficult 2018 which saw 49% wiped off its share price.

In particular, despite various challenges, the US market is performing strongly. Given that the region is responsible for over 40% of group revenue, success on the other side of the pond is critical to the company’s fortunes. 

• Invest with ii: Top UK Shares | Top US Stocks | Share Dealing with ii

There has been a slowdown in the US vaping market, however, with Presidential comments suggesting that the outright banning of e-cigarettes is rather more than just a possibility. 

Source: TradingView Past performance is not a guide to future performance

This is not to say that BAT will necessarily be directly affected, since its products are generally not those in the firing line of the US authorities, but nonetheless the moves of the regulators is an ongoing warning shot to the tobacco industry in general.

Even so, BAT considers these "New Category" products to be essential to its long-term growth, as traditional smoking declines. It has underlined that there has been substantial additional investment in the division, where revenue growth is expected to be at the lower end of a range of 30% to 50%. While New category revenues currently only account for less than 5% of overall revenues, it is clearly an area of strategic focus.

More broadly, the group is guiding for overall revenue growth for the year of between 3% and 5%, with adjusted operating profit expected to fall somewhere between an additional 5% and 7%. 

The company’s ability to generate prodigious amounts of cash is reflected by the fact that, even after dividends, full-year free cash flow is expected to be £1.5 billion. Indeed, one of the clear attractions of the “sin stocks” has been, and continues to be, dividend income and the current yield of 6.8% is comfortably covered. Meanwhile, the inelastic demand which accompanies the nature of the underlying product gives BATs strong pricing power.

• A blue-chip poised for major rally
• Can investment trust dividend heroes extend winning streak?
• Income hunters can find great funds on ii’s Super 60 recommended list of investments

The twin concerns which have followed the stock are regulation in general and the company’s own debt pile, the latter of which is within the company’s control and where BATs is showing some signs of focus. The former of the concerns is out of its control, however, and there will inevitably be more regulatory pressure as time goes on.

In the meantime, the company is certainly making hay while the sun shines, even though the share price has been under immense pressure. In the year to date (and from a much lower base) the shares have recovered by around 20%, while over the last year there has been an improvement of 10%, as compared to a 5.5% jump for the wider FTSE 100 index. 

This rollercoaster ride for the share price has strengthened the resolve of the BAT bulls further, where the market consensus of the shares as a ‘strong buy’ is still firmly in place.