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British American Tobacco: A reliable dividend investment in uncertain times.

Opdateret: 3. feb.


We are currently experiencing a lot of market volatility due to high inflation, increasing interest rates, and a devastating war in Europe. No one knows what the near future will bring, so one potential investment strategy could be to consider defensive stocks with a high dividend yield. One such stock is British American Tobacco, and in this analysis, I will investigate if it is time to buy the share.


This is not a financial advice. I am not a financial advisor and I only do these post in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.


Since I have attended the workshop with Phil Town, I have decided to change the layout of my analyses a bit. I will do some more calculations and briefly go through why the company has meaning to me. I have changed the format of the analysis a bit to try to make it shorter and with less numbers. If you want to read more about how I evaluate a company, please go to "MY STRATEGY" on my website.


For full disclosure, I should mention that I at the time of writing, I do own shares in British American Tobacco. I don't hold it in my copytrading portfolio that you can choose to copy but I do hold it in my dividend portfolio. People who have signed up for my newsletter (you can do so at the bottom of this site) are aware that I am currently experimenting with a dividend portfolio consisting of three different stocks. I should also mention that I will make my calculations based on the U.S.-listed stock with the ticker BTI, but I hold the U.K.-listedstock with the ticker BATS. The reason I hold U.K. listed stocks is that there is no withholding tax on dividends in the U.K. Additionally, the fact that I currently own the stock will not affect the analysis as I will maintain objectivity. If you want to purchase shares or fractional shares of British American Tobacco, you can do so through eToro. eToro is a highly user-friendly platform that allows you to get started with as little as $50.



British American Tobacco is the world's largest tobacco company. Since acquiring Reynolds in 2017, they have addedmany traditional tobacco brands to their portfolio, including Lucky Strike, Pall Mall, Kent, and Dunhill. While they also have the rights to Camel and Newport in the United States. They also own the following non-combustible brands: Vuse, Glo, Velo, and Grizzly. Like all other tobacco companies, British American Tobacco has a significant brand moat. Tobacco companies are no longer allowed to advertise in many countries; therefore, it seems unlikely that they will have any new competitors. Besides that, smokers usually have a strong brand loyalty, meaning they remain loyal to the same brand for as long as they smoke.


Their CEO is Tadeu Marroco. He joined British American Tobacco in 1992 and has held various positions in the companyuntil he became the CEO in May 2023. He has a degree in electrical engineering from the Universidade Federal do Rio de Janeiro and an MBA from the COPPEAD Graduate School of Business in Brazil and the ESSEC Business School inFrance. He was chosen as a CEO because of his outstanding track record in developing teams that deliver on British American Tobacco's business transformation, his consistent focus on education, and his strong financial performance. He was in the center of their "A Better Tomorrow" strategy, which focuses on non-combustibles, and has stated that he will continue with the strategy. Tadeu Marroco is still new as a CEO, but he has stated that inclusivity and collaboration will be at the heart of his leadership approach. He also expressed his desire to build a more agile and progressive company. While we cannot judge Tadeu Marroco yet, I feel comfortable with him at the helm as he has vast experience in both the company and the industry, having been part of British American Tobacco for more than 30 years.


I believe that British American Tobacco has a large brand moat. However, we have some unknowns regarding the management as they recently got a new CEO. Now let us investigate the numbers to see if British American Tobacco does live up to our requirements for a strong moat. In case you want an explanation about what the numbers are, you can have a look at "MY STRATEGY" on the website.


The first number I will investigate is the return on invested capital, also known as ROIC. Ideally, you would like to see a ROIC above 10% in all years. Up until 2017, British American Tobacco had delivered a good ROIC well above the required 10%. However, since 2017, the return on invested capital (ROIC) has been underwhelming. I usually don't like to see a return on invested capital (ROIC) like this, but in the case of British American Tobacco, there is an explanation for the underwhelming ROIC since 2017. That explanation is the acquisition of Reynolds in late 2017. These numbers show that they might have overpaid for Reynolds. Nevertheless, it doesn't keep me from investing in British American Tobacco as I believe the underlying business is still healthy. It is nice to see ROIC improving slightly from 2019 and onwards. The 2022 number is slightly down, but I'm not too concerned as it was affected by the macroeconomic situation we saw throughout the year.



The following numbers represent the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most important of the four growth rates I used in my analyses, which is why I will continue to use it in the future. As you are accustomed to seeing numbers in percentage form, I have decided to provide both the actualnumbers and the percentage growth year over year. Not surprisingly, the numbers are very different before and after the acquisition of Reynolds in 2017. I would have preferred to see an increase rather than a decrease from 2018 to 2020, but the slight decrease does not deter me from investing in the company. It is also nice to see that British American Tobacco was growing their book value + dividend again in 2021 and 2022.



Finally, we will investigate the free cash flow. Free cash flow, in short, refers to the cash that a company generates after covering its operating expenses and capital expenditures. Levered free cash flow is the amount of money a company has remaining after paying all of its financial obligations. I use margins to provide a clearer understanding. Free cash flow yield refers to the amount of free cash flow per share that a company is projected to generate in relation to its market value per share. British American Tobacco has generated positive free cash flow every year for the past 10 years. There is no concern about the slight decrease in free cash flow in some years, as the numbers indicate that British American Tobacco is generating a significant amount of cash. This is evident from the high level of leveraged free cash flow. A high free cash flow yield also indicates that the stock is cheap, but we will discuss this further in the analysis. These numbers are very encouraging to see.



Another important aspect to investigate is a company's debt. We need to determine if the business has a manageable level of debt that can be paid off within 3 years. This can be calculated by assessing the long-term debt to earnings ratio. Doing the calculation on British American Tobacco, I can see that the company has a debt-to-earnings ratio of 5,8 years, which is higher than my preference. However, British American Tobacco has prioritized suspending buybacks and paying off debt, which I believe is a very smart move. Hence, we should expect a decrease in the future.



Like every other investment, British American Tobacco is facing some risks. One risk for British American Tobacco and other tobacco companies is regulation. We have witnessed numerous regulations over the years regarding tobacco. One major change is that tobacco companies are no longer allowed to advertise their combustible products. As I mentioned earlier, it was actually beneficial for British American Tobacco. The ban on menthol cigarettes is another regulation. EU and UK have already banned menthol cigarettes, and now the US is expected to follow suit. Menthol cigarettes make up approximately 33% of the US market, and it is difficult to predict if that will negatively impact the business. When the EU and UK banned menthol cigarettes, British American Tobacco did not experience any significant impact, as most peopleswitched to non-menthol cigarettes. The question is whether it will be the same in the US, where the menthol cigarettesbrand Newport is very strong. Lately, there has been talk about implementing another regulation to reduce the nicotine content in cigarettes. It is difficult to predict whether this will have a negative impact on tobacco companies or not. There are fewer smokers in the world. In the last decade, cigarette sales have dropped by 25-30%. British American Tobacco has outperformed the market, and their sales volume has only declined by 8% over the last decade. Tobacco companies have protected their profits by raising prices. However, the question remains whether this strategy is sustainable in the long run, considering the declining number of smokers. Debt. British American Tobacco has a higher debt level than I would prefer. And while the acquisition of Reynolds is one major reason for the high debt. High debt is not good in an environment with high interest rates. British American Tobacco has approximately 18% of its debt exposed to fluctuating interest rates, and management has mentioned that they expect to see higher rates in their finance costs in 2023. Nonetheless, management is prioritizing debt repayment and aimsto achieve a ratio of 2 to 3 times adjusted net debt to adjusted EBITDA.


It isn't all bad for British American Tobacco, and there is potential for the company as well. One is their "new category". Their new category is primarily described as "reduced-risk products" and includes tobacco heating products (glo), vapor products (Vuse), and modern oral products (Velo). British American Tobacco aims to expand its product portfolio and achieve £5 billion in revenue by 2024, while also striving to attain profitability. The company is making significant progress towards these goals. In the last four years, their revenue in the new category has grown at a compound annual growth rate (CAGR) of 33%, and management expects the revenue in the new category to reach £5 billion by 2025. Their products continue to gain market share, and Vuse holds a 36,6% share of the global market. Velo is particularly popular in Scandinavia, which is one of the regions in the world with the highest consumption of oral tobacco. Both Velo and glo continue to grow their market shares in key markets as well. Cannabis. British American Tobacco owns 20% of the Canadian cannabis company, Organigram. Grand View Research expects the global legal marijuana market to grow at a CAGR of 25,5% until 2030, making it an attractive market to enter.I believe that it is a good deal for both British American Tobacco and Organigram. British American Tobacco will gain exposure to the industry, while Organigram will have the opportunity to collaborate with a company that possesses extensive knowledge in research and development, deep consumer insights, and regulatory expertise. High dividends. Most people invest in British American Tobacco for its dividends. They currently pay an annual dividend of $2,66, which at today's price results in a dividend yield of more than 8%. And it is due to the weak British pound against the U.S. dollar. If the British pound rises against the U.S. dollar, the yield will increase. In the fourth quarter 2022 earnings call, management mentioned their intention to continue growing the dividend. British American Tobacco has paid 30% of its market capitalization in dividends over the past four years. A potentially good investment in a recession. British American Tobacco and other tobacco companies could be good investments during a recession. Research has shown that during the recession from December 2007 to June 2009, tobacco companies still performed well as they outperformed other staples such as beverages, food, cleaning products, beauty, and personal care. It doesn't mean the same thing will happen if we experience a recession again, but I believe it is something to keep in mind.



All right, we have gone through the numbers, potential and risk regarding British American Tobacco, and now it is time for us to calculate a price for British American Tobacco. To calculate price, we will need numbers that I have explained in the "MY STRATEGY" section of the website. I do not want to go through the whole calculation here. I chose to use an EPS of 3,53, which is the number from 2022. I chose an estimated future EPS growth rate of 6% (management has guided with mid-single figure EPS growth, while the growth has been 9% over the last 10 years). I also estimated a future PE of 12 (which is double the growth rate, as the historical PE for British American Tobacco has been higher). Additionally, we already have the minimum acceptable return rate at 15%. Doing the calculations, we come up with the sticker price (some call it fair value or intrinsic value) of $18,78. We want to have a margin of safety of 50%, so we will divide it by 2. This means that we want to buy British American Tobacco at a price of $9,38 (or lower, obviously) if we use the Margin of Safety price.


Our second way to calculate a buy price is the Ten Cap price, which is also explained at "MY STRATEGY". To do so, we need some numbers from their financial statements, keep in mind that all numbers are in millions. The operating cash flow last year was 10.394. The capital expenditures were 656. I tried to look through their annual report to see how much of the capital expenditures were used for maintenance. I couldn't find it, but as a rule of thumb, you can expect 70% of the capital expenditures to be used for maintenance. This means that we will use 459,2 in our further calculations. The tax provision was 2.478. We have 2.258,017 outstanding shares. Hence, the calculation will belike this: (10.394 - 459,2 + 2.478) / 2.258,017 x 10 = $54,97 in Ten Cap price.


The last calculation is the Payback Time. I also described in "MY STRATEGY". With British American Tobacco's Free Cash Flow Per Share at 5,35 and a growth rate of 6%, if you want to recoup your investment in 8 years, the Payback Time price is $56,13.


I believe that British American Tobacco is a good company, and I really like the management as well. I believe it is hard to find a company with a larger moat than British American Tobacco (or other tobacco companies, for that matter). Of course, there are risks associated with investing in British American Tobacco, as there will likely be more regulations in the future, and the specific nature of these regulations is uncertain. Furthermore, the sales volume of their core product is decreasing year over year. However, if you believe that British American Tobacco can expand their non-combustible business to eventually replace their combustible business, it could be a highly intriguing opportunity. Especially because you are getting a high yield while you wait. The stock price won't spike up quickly, so if you choose to invest in British American Tobacco, you will need to have a long-term mindset and be prepared to handle potential volatility. However, if you are able to do so, I believe that purchasing British American Tobacco below the Ten Cap price of $54,97 could be a good idea. This is because you would be getting a 50% discount on the intrinsic value based on two out of three calculations.


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I hope that you enjoyed my analysis. Unfortunately, I cannot do a post of all the companies I analyze. I am available to copy but if you do your own trades, you can follow me on Twitter instead, as I tweet when I buy or sell anything.


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