British American Tobacco (BATS) continues to expect low-single-digit growth in underlying revenue and operating profit over the full year.
This guidance carries a second-half weighting, driven by continued investment in US commercial initiatives, as well as the phasing of new product launches.
In combustibles, volume share year-to-date is up 0.3 percentage points. Value share is down 0.1 points, reflecting geographic mix and commercial positioning in the US, where industry volumes are down 9%.
In New Categories, BATS expects to deliver improved profitability for both the first half and the full year.
The company is targeting free cash conversion of over 90% and is on track to bring net debt within the 2.0–2.5 times underlying cash profit (EBITDA) range by the year-end.
The shares were down 1.5% following the announcement.
Our view
British American Tobacco’s latest trading update failed to excite investors, and it will need to step up performance in the second half if it’s to meet its modest full-year guidance. The company’s 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.
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. That also supports a double-digit dividend yield.
The part sale of the stake in India's ITC, raised proceeds of nearly £1.6bn, which are being returned to shareholders through share buy-backs. Selling down the remaining stake or meeting target debt levels of 2-2.5x underlying cash profit (EBITDA) could see a further step up in shareholder payouts. There can be no guarantees of payouts to shareholders.
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.
British American Tobacco key facts
All ratios are sourced from Refinitiv, based on previous day’s closing values. 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.
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