Monday, January 7, 2019

British American Tobacco (BTI) Dividend Stock Analysis

British American Tobacco p.l.c. (BTI) provides cigarettes and other tobacco products worldwide. It manufactures vapour and tobacco heating products; oral tobacco and nicotine products, such as snus and moist snuff; cigars; and e-cigarettes.

The company is an international dividend achiever, which has managed to reward shareholders with a dividend increase every year since 1997.

Some of BTI's competitors include Altria Group (MO), Phillip Morris International (PM) and Japan Tobacco.

Earnings per share increased from 1.23/share in 2009 to 2.85/share in 2017. The 2017 figures have been adjusted for some one-time items related to the acquisition of Reynolds and the changes in US corporate tax code. The company is expected to earn 2.97 GBP per share in 2018.

The figures are in British Pound Sterling (GBP), since this is a British Company based in the UK. There will be currency fluctuations for US investors in British shares, driven by the changes in currency rates between the US dollar and the British pound. Even if the dividend increases in British Pounds, it is possible that your dividend income in US dollars decreases, if the British pound depreciates in value.

The stock price has plunged in recent months following fears that there will be ban on the sale of menthol tobacco products in the US by the FDA. Even if that happens however, it would take a long time to be implemented. Menthol cigarettes account to almost a quarter of profits. There is also increased pressure on e-cigarettes as well, which have been a growth opportunity for tobacco companies like BTI.

The number of smokers in the developed world is expected to keep declining. This effect is usually offset by price increases which are larger than declines in the number of smokers. BTI is investing in its next generation products, which could spur growth in the future, while also striving to maintain its position in the traditional tobacco products markets. I really like the fact that BTI is well diversified internationally, with exposure to North America, Eastern Europe Middle East and Africa, Europe, and Asia. This diversification spreads the regulatory risk down a notch.

BTI acquired Reynolds in 2017, and is working to integrate the operations, while also realizing the synergies expected from the deal. Future growth can also be achieved by acquisitions, which the company has had a strong history of successfully integrating under its umbrella.

BTI owns leading electronic cigarette brands such as Vype, Ten Motives, VUSE. In addition, it owns the brands iFuse and Glo, which are heated tobacco products. Major traditional tobacco brands include Kent, Dunhill, Lucky Strike, Rothmans and Pall Mall. Strong brands tend to have pricing power, which is good for profits in the long run. Given the global scale of operations, strong customer loyalty to brander products, high barriers to entry, and strong generation of excess cashflows and excess returns on investment, I believe that BTI has a wide moat ( though most other competitors such as Altria, PMI also spot a wide moat as well)

Companies like British American Tobacco can benefit from growth in emerging markets, where smoking is more widespread and declines in smokers are much slower. The company is well positioned in emerging economies.

The annual dividend increased from 70 pence/share in 2008 to 1.75 pounds/share in 2017. The forward annual dividend is 1.92 pounds/share.

The company switched from paying dividends twice per year to a quarterly dividend schedule by 2018. Prior to that it was paying dividends twice per year. The payments differed in size however, although in total they grew each year since at least 1997.

Since this is a UK based company, I analyzed the financial information in British Pounds. As a US based investor, I will be buying the ADR’s traded on NYSE, quotes in US dollars. The dividends in US dollars will fluctuate due to currency fluctuations between the dollar and the pound. In the long run however, these should not have that much effect, assuming that the underlying business model is not fundamentally impaired. 

The dividend payout ratio has increased from 57% in 2008 to 61% in 2017. The forward payout ratio is at 65%. While the payout ratio seems high, this is actually on the low side for a tobacco company.

The number of shares outstanding decreased between 2008 and 2016. The acquisition of Reynolds in 2017 for cash and stock increased the number of shares outstanding. I believe that while management will be prioritizing debt reduction over time, there should be some room for further share buybacks in the future.
The shares of British American Tobacco trade at a low valuation at just 8.70 times forward earnings and have a high dividend yield of 7.40%. Based on the forward payout ratio of 65%, the dividend looks safe. I view the stock as attractively valued today. There are plenty of other tobacco companies to choose from these days, including Altria and Phillip Morris International. While the future is cloudier, given the risk of obsolescence from other products, the valuations are compelling. If the dividend is at least maintained, investors should be able to generate some decent returns over the next decade.

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