British American Tobacco: A solid dividend play in uncertain times.
Opdateret: 10. apr.
We are currently experiencing a lot of market volatility due to high inflation, increasing interest rates and a horrible war in Europe. No one knows what the near future will bring, so one place to invest could be in defensive stocks with a high dividend yield. One of such stocks 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 hold it in my dividend portfolio. People that have signed up for my newsletter (you can do so in the bottom of this site) know that I'm experimenting with a dividend portfolio where I hold three different stocks. I use my monthly extra income to buy these stocks, while I also reinvest the dividends. Everyone can get an extra monthly income, which could turn into significant wealth over time. If you have some hours to spare and want a monthly income, you can read my suggestion here. 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. listed stock with the ticker BATS. The reason I hold the U.K. listed stock is that there is no withholding tax on dividends in the U.K. And finally, the fact that I currently own the stock won't affect the analysis as I will keep it unbiased.
British American Tobacco is the world largest tobacco company. Since their acquisition of Reynolds in 2017, they have many of the traditional tobacco brands in the 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 huge brand moat. Tobacco companies are no longer allowed to advertise in many countries, thus is seems unlikely that they will have any new competitors. Besides that, smokers usually have a very strong brand loyalty, which means they stick to the same brand as long as they smoke.
Their CEO is Jack Bowles. He joined British American Tobacco in 2004 and has held various positions in the company until he became the CEO in 2019. He is educated from IPAG Business School in Paris. He was chosen as a CEO because he throughout his career in British American Tobacco had shown excellent strategic leadership that resulted in growing business and driving production, while he is also known for building strong management teams. He believes that to have a successful organization you need to prioritize employees, and has mentioned that he is passionate about ownership, accountability and delivery, and empowering leaders across the organization to keep it moving forward. He has been credited to have played a key role in developing their noncombustible business, which I will write more about later. Under his leadership he wants British American Tobacco to become a stronger, simpler, and faster organization. Personally, I like that he has experience from many different areas of the business and from many different geographies (Europe, Asia-Pacific and South America). It should also be mentioned that British American Tobacco has been certified as Global Top Employer in six consecutive years. I feel quite confident that his vast experience in the industry and company will help British American Tobacco to grow moving forward.
I believe that British American Tobacco has a huge brand moat. Furthermore, I really like the management. 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 investment 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 ROIC has been underwhelming. I usually don't like to see a ROIC like this but in the case of British American Tobacco, there is an explanation for the underwhelming ROIC since 2017 and that 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 underlaying business is still healthy and 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 next numbers are the book value + dividend. In my old format this was known as the equity growth rate. It was the most important of the four growth rates I used to use in my analyses, which is why I will continue to use it moving forward. As you are used to see the numbers in percentage, I have decided to share both the numbers and the percentage growth year over year. Not surprisingly the numbers are very different from before and after the acquisition of Reynolds in 2017. I would have liked to see an increase rather than a decrease from 2018 to 2020 but the small decrease doesn't keep me from investing in the company. It is also nice to see that British American Tobacco was growing their book value + dividend in again in 2021 and 2022.
Finally, we investigate the free cash flow. In short, free cash flow is the cash a company generates after it has paid for operating expenses and capital expenditures. British American Tobacco is free cash flow positive every year in the last 10 years. There is no concern about the free cash flow decreasing slightly in some years, as the numbers show that British American Tobacco is making a lot of cash which is evident by the high leveraged free cash flow. A high free cash flow yield also indicates the stock is cheap, but we get back to that later in the analysis. These numbers are very encouraging to see.
Another important thing to investigate is debt, and we want to see if a business has a reasonable debt that can be paid off within 3 years by calculation long-term debt to earnings. Doing the calculation on British American Tobacco, I can see that British American Tobacco has 5,8 years earnings in debt, which is higher than I like. However, British American Tobacco has prioritized to suspend buybacks and pay off debt, which I believe is a very smart move. Hence, we should see being lower moving forward.
Like every other investment, British American Tobacco is facing some risks. One risk for British American Tobacco and other tobacco companies is regulations. We have seen many regulations over the years when it comes to tobacco. One major one is that tobacco companies are no longer allowed to advertise their combustible business. As I wrote previously, it was actually good for British American Tobacco. Another regulation is the ban of menthol cigarettes. EU and UK have already banned menthol cigarettes, and now the US is expected to do the same. Menthol cigarettes is approximately 33 % of their US market, and it is hard to predict if that will hurt the business. When EU and UK banned menthol cigarettes, British American Tobacco did not "experience any material impact", as most switched to non-menthol cigarettes. The question is if it will be the same in the US where their menthol cigarettes brand Newport is very strong. Lately, there is talk about another regulation to cut nicotine in cigarettes, and it is hard to predict if this will hurt tobacco companies or not. Less smokers in the world. In the last decade cigarette sales has dropped between 25-30 %. British American Tobacco has performed better than the market, and their sale volume has only declined by 8 % over the last decade. Tobacco companies have protected their profit by raising prices, but the question is if that is sustainable over time as there will be less and less smokers moving forward. Debt. British American Tobacco has a higher debt than I would like. And while the acquisition of Reynolds is one large reason for the high debt. High debt is not good in a high interest rates environment. British American Tobacco has approximately 18 % of debt exposed to fluctuating interest rates, and management has mentioned to see higher rates in their finance cost in 2023. Nonetheless, management is prioritizing to pay off debt and wants to reach 2 to 3 times adjusted net debt / adjusted EBITDA.
It isn't all bad for British American Tobacco and there are potential for the company as well. One is their "new category". Their new category is mainly described as "reduced-risk products" and consists of tobacco heating products (glo), vapour products (Vuse), and modern oral products (Velo). British Amrican Tobacco wants to grow these products to reach £5 billion in revenue and to reach profitability by 2024, and they are well on their way. In the last four years, their new category revenue has grown by a CAGR of 33 %, and management expects new category to reach £5 billion revenue by 2025. Their products continue to gain market shares and Vuse has a 36,6 % of the global market share. Velo is especially large in Scandinavia, which is one of the regions in the world with the highest consumption of oral tobacco. Both Velo and glo continues to grow their market shares in key markets as well. Cannabis. British American Tobacco has 20 % ownership of Canadian cannabis company Organigram. Grand View Research expects the global legal marihuana market to grow by 25,5 % CAGR until 2030, which means it is an attractive market to be in. I believe that it is a good deal for both British American Tobacco and Organigram as British American Tobacco gets exposure to the industry, while Organigram gets to collaborate with a company that has great knowledge in research and development, deep consumer insights, and regulatory expertise. High dividends. Most people invest in British American Tobacco for dividends. They currently pay an annual dividend of $2,66, which at today's price is a dividend yield of more than 7 %. And it is with a weak British pound against the U.S. dollar. If the British pound rises against the U.S. dollar, the yield will be higher. In the fourth quarter 2022 earnings call, management mentioned that they want to continue to grow the dividend. British American Tobacco has paid 30 % of their market cap in dividends in the last 4 years. A possible good investment if we see recession. British American Tobacco and other tobacco companies could be a good investment during recession. Research has shown that during the recession from December 2007 to June 2009, Tobacco companies still performed well as the outperformed other staples such as beverages, food, cleaning products, beauty, and personal care. It doesn't mean the same will happen if we see recession again, but I think it is something to be aware of.
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 at 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 % the last 10 years), Estimated future PE 12 (which the double of the growth rate, as the historically PE for British American Tobacco has been higher) and we already have the minimum acceptable return rate on 15 %. Doing the calculations by using the formula I described in "MY STRATEGY", we come up with the sticker price (some call it fair value or intrinsic value) of $18,78, and we want to have a margin of safety on 50 % , so we will divide it by 2 meaning that we want to buy British American Tobacco at 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 was 656. I tried to look through their annual report to see, how much of the capital expenditures were used on maintenance. I couldn't find it though, so as a rule of thumb, you expect 70 % of the capital expenditures to be used on maintenance, meaning 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 be like 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 the Free Cash Flow Per Share at 5,35 and a growth rate of 6 %, if you want your purchase back in 8 years, the PAYBACK TIME price is $56,13.
I do believe that British American Tobacco is good company and I really like the management. I believe it is hard to find a company with a larger moat then British American Tobacco (or other tobacco companies for that matter). Of course, there are risks when investing in British American Tobacco, as there will be more regulations in the future, and no one knows how these will be. Furthermore, sales volume is decreasing year over year in their core product. However, if you feel like British American Tobacco can grow their non-combustible business to eventually take over for their combustible business, it could be a very interesting place to be. Especially because you are getting a high yield while you wait. The stock price won't spike up fast and if you invest in British American Tobacco, you will need a long-term mindset, while also being able to stomach potential volatility. However, if you can do so, I believe that buying British American Tobacco below the TEN CAP price of $54,97 is a good idea, as you get it as 50 % discount on intrinsic value on two out of three calculations.
My personal goal with investing is financial freedom. It also means that to obtain that, I do different things to build my wealth. If you have some extra hours to spare each month, you can turn a few hours a week into a substantial amount of money in a few years. If you are interested to know how to do it, you can read this post.
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.
Some of the greatest investors in the world believe in karma, and to receive, you will have to give. If you appreciated my analysis and want to get some good karma and show your appreciation, I would kindly ask you to donate a bit to Safe Haven For Donkeys. It is an organization that helps donkeys in Israel and the Palestinian Territories. If you have a few bucks to spare and you enjoyed my writing, you would receive lots of good karma, if you would donate a little here. Every contribution matters no matter how little. Thank you.