Company Overview: British American Tobacco p.l.c. (NYSE: BTI) is focused on manufacturing and selling cigarettes, tobacco, and other nicotine products internationally. The company distributes its products to retail outlets across the U.S., Europe, and North Africa (ENA), Americas and Sub-Saharan Africa (AMSSA), and the Asia Pacific and Middle East (APME) regions. As of July 28, 2021, there are 2.29 billion American Depository Shares (ADS) of BTI listed and outstanding (each ADS representing one ordinary share).

BTI Details

Key Brands: The company’s key brands in its Combustibles segment include Dunhill, Kent, Lucky Strike, Pall Mall, and Rothmans. Vuse, one of the brands under its New Category segment (which offers affordable alternatives to traditional nicotine consumption), was declared the world's first global carbon-neutral vaping brand in May 2021.

Key Takeaways for H1FY21 (ended June 30, 2021):

• Slight Decline in Total Revenue: In H1FY21, the company’s revenue was GBP 12.18 billion, representing a marginal 0.8% decline YoY. This decline was owing to the effect of an 8.9% translational foreign exchange headwind. On a constant currency basis, total revenue grew by 8.1% YoY, primarily due to significant growth in the New Categories segment plus effects of recovery from the COVID-19 pandemic in FY20.
• Robust Growth in the New Categories Segment: BTI reported a 40.4% growth YoY in the New Categories segment during H1FY21, owing to the addition of approximately 2.6 million new users under the non-combustible product consumer base during the period (reaching 16.1 million).
• Building Global Brands: During the interim period, BTI focused on strengthening its Vuse, Velo, and glo brands, and invested an additional GBP 346 million for their growth.
• Exploring the Cannabis Industry: On March 11, 2021, BTI signed a strategic collaboration agreement with a subsidiary of Organigram Holdings Inc. (NASDAQ: OGI) and acquired a 19.9% stake in OGI, with a focus on engaging in research and product development activities of adult cannabis products.

Supportive Evidence for New Categories Products: On July 01, 2021, BTI announced that in a year-long study conducted on the effects of glo, BTI’s tobacco heating product (THP), on UK-based smokers aged 23 to 55, it was observed that switching to glo showed a significant reduction in indicators of potential harm compared with participants continuing to smoke cigarettes.

Segment Wise Revenue Distribution:

• Combustibles Segment: Revenue for H1FY21 amounted to GBP 10.53 billion, down 3.0% YoY from GBP 10.85 million in H1FY20.
• New Categories Segment: This segment generated GBP 883 million in revenues, comprised of GBP 398 million from the Vapour market, GBP 359 million from THP, and GBP 126 million from Modern Oral category.
• Traditional Oral Segment: Revenue was down 3.3% YoY to GBP 558 million during H1FY21. Total units sold during the period were 4.1 billion sticks equivalent.

Other Key Findings in H1FY21:

• During the period, 45.7% of the total revenue was generated from the U.S., and APME, AMSSA, and ENA regions accounted for 16.88%, 14.75%, and 22.68% of the total revenue, respectively.
• For H1FY20, operating profits were GBP 4.91 billion, down 3.7% from GBP 5.10 billion in H1FY20. The operating margin for the period was 40.3%.
• Net profit for H1FY21 was GBP 3.33 billion, compared to GBP 3.54 billion in H1FY20. This represents diluted earnings per share of GBpence 141.6.

Region-wise performance; Analysis by Kalkine Group

Balance Sheet & Liquidity Position:

• Reduced Cash Balance: The company exited H1FY21 with a cash balance (including current investments) of GBP 3.35 billion, slightly lesser than GBP 3.38 billion at the end of FY20.
• Cashflow from Operations: Operating cash inflow in H1FY21 was GBP 2.25 billion vs. GBP 3.48 billion in H1FY20. This was a result of the phasing of BTI’s excise payments in FY20.
• Declining Debt: BTI’s total debt amounted to GBP 45.01 billion at H1FY21 end, declining from GBP 50.46 billion as of June 30, 2020.

Key Metrics: In H1FY21, Operating and net margins were 40.3% and 27.3%, higher than the H2FY20 figures of 36.0% and 21.6%, respectively. EBITDA margin stood at 44.5%, slightly lower than the year-ago figure of 46.6%. Debt/Equity of the company was 0.72x as of June 30, 2021, vs. 0.73x as of June 30, 2020.

Profitability and Leverage Profile; Analysis by Kalkine Group 

Top 10 Shareholders: The top 10 shareholders (in terms of ownership of ordinary shares listed on the LSE) together form around 32.13% of the total shareholding, while the top 4 constitute the maximum holding. Spring Mountain Investments, Ltd. and BlackRock Institutional Trust Company, N.A. hold the maximum stake in the company at 6.59% and 5.79%, respectively, as also highlighted in the chart below: 

Top 10 Shareholders; Analysis by Kalkine Group 

Risk Analysis:

• Illicit Tobacco Trade: Production and supply of cheap illegal and counterfeit tobacco products, tobacco trafficking, smuggling of genuine products, etc. pose a significant threat to the company and the legitimate tobacco industry at large.
• Stringent Regulatory Scrutiny: The tobacco industry is amongst the most highly regulated in the world, and the imposition of restrictions could affect BTI’s ability to commercially market its products.
• Volatile Tax Regime: BTI is also exposed to unexpected and significant increases or structural changes in tobacco and nicotine-related taxes in its key markets.
• Forex Headwinds: As reflected in the company’s H1FY21 results of operations, any adverse movement in foreign exchange rates may impact the financial performance of the company.

Outlook: The company will continue to make additional investments for further growth in its New Categories segment in H2FY21, and it estimates that the losses from this segment will continue reduce in FY21, reaching profitability status by FY25.

• On the global front, the tobacco industry volume for FY21 is expected to decline by -1.5% (from -3% previously), due to the strong recovery expected in the emerging markets (Bangladesh, Pakistan, Vietnam, Brazil, and South Africa).
• Consumption volume in the U.S. is expected to be down -5.5%, owing to the uncertainties on the macro-economic level.
• BTI expects over 5% growth in constant currency revenues and aims to generate GBP 5.0 billion from the New Categories segment in FY25.
• Constant currency-adjusted EPS will grow in mid-single digits in FY21, even with the estimated transactional foreign exchange headwind of 2%.

Valuation Methodology: EV/EBITDA Multiple Based Relative Valuation (Illustrative)

Source: Analysis by Kalkine Group

*% Premium/(Discount) is based on our assessment of the company’s NTM trading multiple after considering its key growth drivers, economic moat, stock's historical trading multiples versus peer average/median, and investment risks. 

Stock Recommendation: Over the last one month, BTI has corrected ~4.39%. The stock is currently close to the mid-point of its 52-weeks trading range of USD 31.60 to USD 41.14. We have valued the stock using the EV/EBITDA multiple-based illustrative relative valuation method and arrived at a target price with an upside of high teens (in percentage terms). We believe that the company can trade at a slight discount compared to its peer’s average, considering the risks involved with the extensive regulatory scrutiny, volatile tax regimes, competition from counterfeit product supply, and foreign exchange risk. We have taken peers like Philip Morris International Inc. (NYSE: PM) and Altria Group, Inc. (NYSE: MO), among others. Considering the growth in the New Categories segment, decreasing debt, encouraging outlook, robust dividend yield, and current valuation, we give a “Buy” recommendation on the stock at the closing price of USD 37.93, down ~1.74% as of July 28, 2021.

BTI Technical Chart, Data Source: REFINITIV 

Note 1: The reference data in this report has been partly sourced from REFINITIV.

Note 2: Investment decision should be made depending on the investors' appetite for upside potential, risks, holding duration, and any previous holdings. Investors can consider exiting from the stock if the Target Price mentioned as per the valuation has been achieved and subject to the factors discussed above.

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