Don’t stub this company out just yet because it could still be going strong for years to come
If British American Tobacco can put the North Korean fiasco behind it and improve momentum in next-generation products, investors can reap the rewards
Afine from the US authorities, the sudden departure of the chief executive and ongoing regulatory pressure in the US are all negatives for British American Tobacco and the share price continues to slide lower – and lower. Investors who run strict environmental, social and governance (ESG) screens will just roll their eyes and move on, but those investors who seek income or value and do not mind where they find either have a tougher choice to make if they own the stock. Some may give up in frustration, but others may look at how well cash flow covers the forecast 9pc dividend yield and how the shares’ valuation looks compared with international peers and hold on grimly.
If a company was already under close scrutiny from investors and regulators alike on ESG grounds, and that same company was striving to prove itself in this area, the last thing you would expect it to do would be to take the risk of sanctions-busting. British American Tobacco was actually that stupid, and it has been fined $635m by the US Department of Justice (DOJ) and the Office of Foreign Assets Control for selling to and trading with North Korea between 2007 and 2017.
Income-seekers will be galled by the financial and reputational hit and perhaps question their financial commitment, too, given the poor behaviour involved. Their only sources of solace are that BAT did stop trading with Pyongyang six years ago and the company had already set aside cash to pay the fine, so the financial hit was limited, even if the reputational one was not. Moreover, the nature of the deferred prosecution agreement (DPA) means the case is closed. Whether the immediate replacement of Jack Bowles as chief executive with Tadeu Marroco is linked to the DOJ case or not – and Mr Bowles led BAT’S Asia Pacific operations for some time – neither he nor the firm has been accused of, or admitted to, wrongdoing, under the terms of the DPA.
That will not appease Esg-oriented investors or those who are concerned over fresh regulatory pushback in the US, where the Food and Drug Administration continues to investigate menthol and flavoured cigarettes. New legislation may be proposed this autumn.
Hardened fans of BAT’S cash flow will also be watching the company’s progress in next-generation products (NGPS), where in America the UK firm lags Philip Morris in heated tobacco, and the Velo oral pouch seems to be struggling for traction Stateside in the face of competition from Zyn and on!, produced by Swedish Match and Altria respectively.
All of these cross-currents are working against the share price, which is languishing near 18-month lows and
‘Fans of BAT’S cash flow will be watching the company’s progress in nextgeneration products’
trades no higher now than it did in 2011. A further negative factor may be the decision to put share buybacks on hold, following completion of last year’s £2bn programme, in favour of debt repayment. That is a stark contrast to Imperial Brands’ continuation of its buyback.
However, this policy seems prudent, given how BAT’S net liabilities, adjusting for pensions and assets up for disposal, come to some £38bn. This column remains a firm believer that less debt means less risk and less risk can mean a higher multiple of earnings over time. Net debt has already come down from a peak of £47bn in 2017.
In addition, free cash flow, after capex, tax, interest, pension contributions and leases still came to £6.5bn in 2022 and that comfortably covered the £4.9bn dividend payment, doubtless to the satisfaction of income seekers.
This column has no interest in calls for the company to shift its listing to
New York in an attempt to close the valuation gap with US peers Philip Morris and Altria, even if they trade on 12 and eight times earnings before interest, taxes, depreciation and amortisation respectively, compared with BAT’S seven times multiple, especially if the plan would be to then restart buybacks after any switch.
Purchasing stock at a higher valuation would make no financial sense and use up cash that could be used to invest in the firm’s day-to-day business. But such chatter does highlight the valuation gap that exists, and it is now the job of the new chief executive, and the board, to put the North Korean fiasco behind them, improve momentum in nextgeneration products and entrench BAT’S competitive position, so it can keep generating cash, pay those fat dividends, decrease borrowings and in time perhaps restart buybacks.
Income seekers may still find the fat yield very tempting.