BAT Undervalued say Analysts

British American Tobacco is now undervalued say Morningstar analysts, and it is expected to grow its dividend in the future. Is this an opportunity to buy?

Thomas Mullarkey, CFA 13 January, 2014 | 10:26AM
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British American Tobacco's (BATS) global scale and brand strength, combined with its pricing power and addictive nature of its products, give the company a wide economic moat (competitive advantage), in our opinion. While escalating excise taxes, proliferating smoking bans, and illicit cigarettes may put headwinds on British American's volumes, we think that the firm's geographic breadth will enable the firm to steadily improve its earnings.

Although British American lacks an iconic international brand like Philip Morris International's (PM) Marlboro, its Global Drive Brands (including Dunhill, Kent, Pall Mall, and Lucky Strike) are well known and have been gaining share over the past several years. The strength of these brands gives British American pricing power in many key markets and helps position the firm for growth. Approximately 75% of the company's cigarettes are sold in developing markets. We believe that many of these emerging markets have meaningful growth opportunities as per capita cigarette consumption grows in the coming years and as consumers switch to more premium cigarettes. The company's volume is roughly evenly divided among premium, mid-price, and low-price brands. This breadth of products should help dampen the blow of any economic slowdown should consumers temporarily trade down to lower-priced cigarettes.

Excise tax increases and further regulations are constant risks for tobacco manufacturers. Nonetheless, we believe that British American Tobacco is well poised to maintain its pricing power, to preserve healthy operating margins, and to continue paying a meaningful dividend for years to come. We anticipate that British American will continue to pay out roughly two thirds of its adjusted net income as dividends. Given that the company plans to buy back around GBP 1.5 billion of its stock in 2013, and the company's addictive products possess admirable pricing power, we anticipate the average dividend per share will steadily increase by about 6%-8% per year for the foreseeable future.

We increased our fair value estimate to £35 from £33, following the company's first half results of 2013.  Consumption growth in developing and emerging countries and the ability to consistently raise prices should more than offset volume declines in mature markets during the foreseeable future. “e forecast annual revenue growth of 4%, which is roughly in line with the company's long-term targets to deliver 3%-4% revenue growth.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
British American Tobacco PLC2,392.00 GBX0.59Rating
Philip Morris International Inc102.20 USD0.22Rating

About Author

Thomas Mullarkey, CFA  is an equity analyst at Morningstar.

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