Interactive Investor

British American Tobacco still a ‘buy’, but for how long?

17th February 2021 10:09

Richard Hunter from interactive investor

Growing opposition to sin stocks is a worry, but strong cash flow and diversification are plusses.

British American Tobacco (LSE:BATS)’s prodigious cash-generating ability has carried it through the tortuous environment of the last year.

The company has navigated its way to another year of comfortable profit.

That is despite a ban on cigarettes sales in South Africa between March and August, severe travel restrictions due to the pandemic affecting lines such as duty free and a traditional industry in decline.

BAT generated £9.8 billion of net cash for the year, with pre-tax profit rising 9.6%, underpinned by adjusted operating margin of 44%, itself up 1% in the period.

Earnings per share rose by 12%, and revenues from traditional cigarette sales rose 2.8% despite a volume decrease of 4.5%, further proof if it were needed of the company’s pricing power.

Meanwhile, the level of income also allowed for an additional investment of some £430 million in new category products, while the annual increase to the dividend payment adds to the existing punchy yield of 7.7%, in what has been a constant attraction to income-seekers in otherwise dividend-deprived times.

Each of the new category products has shown significant volume growth, with Vapour rising by 52%, Tobacco Heated Products by 19% and Modern Oral by 62%. The company continues to recognise the shifting sands within the industry by increasing its investment away from traditional cigarettes. Currently accounting for just 12% of group revenues, the direction of travel is nonetheless becoming established.

All is not plain sailing, however, and BAT recognises that the adjusted net debt position of £40 billion needs constant monitoring. Cost savings in the period totalled £660 million (with the aim of annualised savings of £1 billion by 2022) and the profit figure has also enabled a slight reduction in the number from a previous level of £42.5 billion.

In addition, despite the increase in pre-tax profits, the number is short of market expectations by enough of a distance to depress the share price in early trade.

More broadly, the industry is one where, quite apart from changing tastes, the threat of litigation and regulation have been an overhang for some considerable time. Further out, although not necessarily in evidence yet, is the possibility that investors will choose to eschew the tobacco sector as an investment destination given the growing popularity of ethical considerations.

Such concerns have dragged on a share price which has lost 18% over the last year, as compared to a decline of 9% for the wider FTSE 100. Even so, with its defensive qualities, strong cash generation and a generous dividend yield alongside, the market consensus of the shares remains resolutely positive on prospects, coming in at a strong ‘buy’.

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