ii view: BAT’s dividend remains a major attraction

High new vape product ambitions and an attractive dividend yield continue to offset ethical concerns for many investors.

Second-half trading update

• Maintaining 2020 guidance
• Constant currency adjusted revenue growth now expected to be at the high end of the 1-3% range
• Mid-single figure constant currency adjusted diluted earnings per share growth
• Continued deleveraging of the balance sheet
• A dividend pay-out ratio of 65% of adjusted diluted EPS and growth in sterling terms

Chief executive Jack Bowles said:

"We are transforming our business in order to build A Better Tomorrow. Reducing the health impact of our business through providing a range of enjoyable and less risky products is the greatest contribution we can make to society. We continue to be clear that combustible cigarettes pose serious health risks, and the only way to avoid these risks is not to start or to quit. BAT encourages those who would otherwise continue to smoke to switch completely to scientifically substantiated reduced risk alternatives. 

"Covid-19 has made this a difficult year for everyone, and I am proud of the continued commitment and dedication of our people around the world. It is their hard work that has ensured we are on track to deliver a strong set of results in 2020, given this backdrop. We are confident about the future for BAT and are committed to our 2025 New Category revenue ambition of £5 billion. While the environment remains uncertain, due to the continuing challenges of Covid-19, the business is performing strongly."

ii round-up:

Cigarette and vaping company British American Tobacco (LSE:BATS) has raised its full-year revenue forecast given a lower-than-expected hit from the pandemic, although left its earnings expectation unchanged. 

Revenue growth is now expected to be at the upper end of its previous 1% to 3% growth range following  a 2.5% sales reduction from Covid-19, down from a previous 3% estimate. Travel related disruption and ultra-quiet airports and ferries hindered performance. 

Better sales are being offset by ongoing investment into its new category or vaping products. 

BAT shares drifted marginally lower in UK trading, bringing their year-to-date fall to just over 10%. Shares for UK rival Imperial Brands (LSE:IMB) are down by 17% in 2020. Both BAT and Imperial shares have risen by around a fifth since late March pandemic lows. 

BAT launched its first new category product - vaping - not long after 2012. It is now targeting new category revenue of £5 billion come 2025. Sales growth was again flagged. Last year, revenue for this lower health risk product arena grew by nearly a third to £1.2 billion. Compared to overall group revenues of almost £26 billion – up nearly 6%.

A series of deaths in the USA during 2019 linked to new category products raised questions over their safety. However, many such deaths appeared to be linked to those vaping a cannabis compound. Excluding US vaping, new categories sales rose by almost 40%. 

Debt reduction also remains a focus for the relatively new chief executive. Adjusted net debt over the course of 2019 fell by 4% to just under £42 billion. 

A dividend payout ratio of 65% of adjusted diluted earnings per share and growth in sterling terms is being targeted. In February, BAT declared an interim dividend of 210.4p per share, payable in four equal quarterly instalments of 52.6p per ordinary share – up from the prior year’s total of 203p per share. 

Full-year results are scheduled for 17 February. 

ii view:

The negative impact on health from smoking is no longer disputed. As such, tobacco companies like BAT have been investing in alternative products. However, there has been concern over user deaths and regarding new vape users who previously did not smoke and may have been attracted to favoured products. As such, government regulation, particularly in BAT's core US market, has been rising.

For investors, ethical issues mean the industry is untouchable for many. Worries regarding new category products cannot be dismissed either. Heavy product investment and hoped-for sales growth now feed strongly into prospects. 

But a push by the tobacco industry itself to replace dangerous combustibles with lower risk products marks a significant change of direction. A forecast dividend yield of over 7% is also highly attractive in today’s ultra-low interest rate environment. And an estimated price/earnings (PE) ratio of under 10, and comfortably below the 10-year average, suggests some accounting for new category concerns already. In all, while some caution remains highly sensible, the balance between risk and reward may just be swinging in favour of the latter.  

Positives:

• Increased focus on new category vape products
• Attractive dividend income

Negatives

• Covid-19 travel bans hitting sales
• Doubt over the safety of new category products has risen

The average rating of stock market analysts:

Strong buy