British American Tobacco's (BATS) 2023 organic revenue growth is now expected to come in at the bottom of the 3-5% range, as US combustible sales remain under pressure. The group will incur a non-cash charge of about £25bn largely reflecting a fall in the estimated value of certain US brands. Mid-single digit growth guidance for underlying earnings per share remains intact.
New Categories are expected to be broadly breakeven in the current period, two years earlier than originally expected. The group has set a target for non-combustibles to drive 50% of revenues by 2035.
In 2024 headwinds on combustibles are expected to continue. Investment in the group's transformation is also set to accelerate. Overall revenue and underlying operating profit growth is expected to be in the low single digits.
By 2026 that's expected to improve to a 3-5% growth rate for revenue, with operating profit growth in the mid-single digits.
The shares were down 7.6% following the announcement.
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Our view
British American Tobacco is fighting hard to maintain market share in traditional combustible products (cigarettes and cigars) in its largest market, the United States. This is proving challenging and it's weighing on financial performance. In other territories the picture looks brighter. There are also rays of hope that BATS' efforts to stem the tide in the US are bearing fruit. But it's against the backdrop of a declining market. For the immediate future, combustibles remain the key driver of profitability so any further slowdown could further dent investor sentiment.
The group was early to recognise changes in consumer behaviour and is increasingly pinning its hopes for the future on its portfolio of 'smokeless' products, namely vapes, heated tobacco and oral pouches. We're impressed by the progress made so far. These New Categories are set to reach profitability in 2024, two years ahead of the original plan. There's now a target in place for them to generate over half of total revenues by 2035. We admire the ambition but there will be challenges along the way. There is some evidence to suggest that these products pose a reduced health risk compared to cigarettes, but they are coming under increasing scrutiny with some products banned in the US earlier this year. There's also mounting pressure for higher taxes going forward.
The company itself has called out the trade in illicit disposable devices as an immediate concern, and there's no certainty that enforcement will improve. It's too early to call how the long-term profitability of these products will compare to traditional products. This could undermine BATS' attractive operating margins which have remained over 40% despite recent market challenges and the spike in inflation.
Consistently high cash flows do mean that the company is well placed to make the investments necessary to keep pivoting away from cigarettes. It also leaves room to support an attractive dividend yield which, following a persistent decline in the company's market value, is now touching double digits. But share buybacks remain on hold and are unlikely to be reconsidered until net debt drops a little further. Disposal of non-core assets could help with this but neither that, nor indeed any shareholder distributions can be guaranteed.
Whilst the yield remains a key lure for investors, recently it hasn't been enough to compensate for capital losses. The weakness seen in the valuation suggests that there's still a job to be done in convincing investors that New Categories can underpin BATS' future. Successful execution of the strategy could well drive a re-rating. Things are certainly moving in the right direction, but there are likely to be bumps along the way, so investors need to be prepared for some volatility.
Environmental, social and governance (ESG) risk
The food and beverage industry tends to be medium-risk in terms of ESG though some segments like agriculture, tobacco and spirits fall into the high-risk category. Product governance is a key risk industry wide especially in areas with strict quality and safety requirements. Labour relations and supply chain management are also industry wide risks, with other issues varying by sub-sector.
BATS' overall management of ESG issues is strong according to data by Sustainalytics. But we do have some concerns. Recent controversies include accusations of using corporate social responsibility activities to influence government officials and bypass tobacco policies. With tobacco being on the exclusion list of certain institutional investors, product impact is key and the company's commitment to public health, as well as broader ESG disclosures, do not obviously go beyond minimum legal requirements.
BATS key facts
All ratios are sourced from Refinitiv. Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.
This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. It was correct as at the date of publication, and our views may have changed since then. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.
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