Interactive Investor

Difficult times for British American Tobacco 

6th June 2023 08:43

by Richard Hunter from interactive investor

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With shares down 30% in under a year and the tobacco giant facing a number of headwinds, our head of markets picks apart the latest update.

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    British American Tobacco (LSE:BATS) is in a difficult place at the moment, with some previous ghosts coming back to haunt the group’s prospects.

    The recent fine of £508 million for sanctions busting in North Korea left a bad taste in the mouth for investors, while regulation more generally has been putting pressure on not only traditional cigarettes but also the likes of flavoured vapes in parts of the US. Meanwhile, litigation has been a sporadic issue over the last decade, while governments have increasingly become involved in punishing the sector with health benefits in mind.

    In the US, traditional cigarette sales have been disappointing, while global tobacco volumes are expected to decline by 3% over the full year. BAT is also looking to scale down its debt and deleverage the balance sheet, which was the cause of some disappointment in not repeating the previous year’s share buyback programme. That being said, the group is aiming to sustainably return excess cash to shareholders and in any event, the current dividend yield of 9% certainly falls into the category of generously paying investors to wait.

    The shares had previously been on a good run, with the rotation into value stocks from growth providing a tailwind, and with a more defensive attitude given market volatility refocussing attention on the likes of the oils and tobacco shares. However, more recently the dissenting voices have become louder, despite the group’s undoubted ability to benefit from strong cash generation and pricing power. In addition, there are the additional challenges of a reduced pool of potential investors, with some being unwilling or unable to enter the sector on ethical grounds.

    The general backdrop has accelerated the need to change horses midstream and the new chief executive has confirmed that the current strategy will continue to be pursued, which should at least provide some momentum. The challenge now is to drive the change towards the group’s “New Categories” segment, which comprises Tobacco Heating Products (THP), Vapour and Modern Oral.

      ndeed, there are signs of progress within this increasingly important part of the business. The group added a further 900,000 consumers over the first quarter and remains on track to reach its targets of £5 billion of revenues by 2025, and to hit profitability in 2024.

      Nor is the more immediate picture one of extreme concern. BAT has maintained its guidance for the full year, with expected growth at constant currency of between 3% and 5% weighted towards the second half. At the same time, the group expects further currency tailwinds given its exposure to overseas earnings and the relative weakness of sterling over the period, and an operating cash conversion of over 90% is worthy of note.

      For the traditional products, which still prop up the business overall, there are signs of ongoing resilience. The nature of the products allows for strong pricing power without destabilising demand, which offsets some of the issues the group is facing. Even so, economic pressure generally and a post-Covid normalisation of habits has led to some downtrading, while finance costs have risen due to higher interest rates and the strength of the US dollar.

      Overall, and despite the previous share price strength, investors have been turning their backs on the sector more generally and BAT has been no exception.

      BAT shares have fallen by 27% over the last year, which compares to a marginal dip of just 0.1% for the wider FTSE100, with most of the decline propelled by a drop of 25% over the last six months. The challenges are clear, as are the opportunities and the recent share price performance has additionally raised the prospects of the shares having become much cheaper in terms of valuation.

      Indeed, the market consensus of the shares as a 'buy' recognises the prospects, even if they fall into the category of being higher risk.

      These articles are provided for information purposes only.  Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties.  The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

      Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.

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