British American Tobacco reported first half organic revenue growth of 2.8% to £12.8bn, ignoring the effects of exchange rates. This was driven by a 27.9% increase in new categories.
Meanwhile, sales from combustible products were up just 0.4% where robust pricing offset a 4.9% decrease in volumes. Weakness in the US was offset by performance in other territories.
Underlying operating profits grew by 2.7% to £5.7bn reflecting a stable margin of 44.4%.
Free cash flow grew by 2.2% to £2.3bn, whilst underlying net debt fell from £38.8bn to £37.3bn.
The Group re-iterated full year guidance which includes organic revenue growth of 3-5% and a mid-single digit increase in underlying earnings per share. Management committed to growing the dividend in sterling terms and stands by the long-term pay-out ratio of 65%.
The shares were up 2.4% following the announcement.
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Our view
Global tobacco consumption has been in decline for decades. And there are some signs that this is an accelerating trend. We think new CEO, Tadeu Marroco is doing a good job at navigating these headwinds, and remains on target to deliver top and bottom line growth in 2023.
BATS is a juggernaut, and despite industry challenges, market forecasts expect revenue to continue to inch towards the £30bn mark over the next couple of years. That scale combined with incredible pricing power has resulted in operating margins other consumer goods companies can only dream of. And, with relatively low capital requirements, the group's delivered prodigious amounts of cash despite falling volumes.
Much of that cash is currently tied up in stabilising the balance sheet, and debt reduction is becoming a bigger priority for management. That's behind the decision to pause the share buyback programme. Should underlying net debt levels come down towards the middle of the 2 to 3 times EBITDA (cash profit) range this year, from 2.9 times in 2022, there may be scope for buybacks to resume. However, there's no certainty and analysts are only forecasting limited progress on the debt levels this year.
BATS is notable for its significant emerging market exposure, and has been enjoying top line growth in all markets except its largest the US, where it also has a strong position. However, things are tough here with market share under pressure. That's as consumers down-trade to some of the Group's cheaper brands in the face of economic pressure. BATS has seen some early signs of stabilisation, but we caution that the outlook for US consumers remains challenging.
New categories like vapes and heated tobacco are growing quickly. The division is loss making, and profits are expected to start in 2024. But with continued high levels of investment sustainable growth in profits may still be a while out.
One risk to these products' success is the prospect of further regulatory restrictions. Any rejections of marketing approvals are likely to weigh on sentiment.
The other important thing to consider with tobacco stocks is that many institutional investors can't, or won't, invest in the sector. That can keep a lid on demand, and therefore valuation.
The key attraction, for now, is likely to be the 9.4% prospective yield, one of the highest in the FTSE 100. Analyst forecasts suggest this year's dividend payments are in line with the company's 65% target pay-out ratio, providing some comfort that the yield is achievable. We stress however, that no dividends can ever be guaranteed.
For investors looking for more blue-sky potential, BATS is one of the more exciting names for next-gen tobacco products. But, whilst that part of the business is still loss making, we would urge caution.
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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