British American Tobacco Still Undervalued

BAT share price fell sharply yesterday, but Morningstar analysts believe there is significant upside to tobacco valuations

Philip Gorham 17 October, 2018 | 12:21AM
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British American Tobacco Brand Lucky Strike

Morningstar analysts are retaining their £45 fair value estimate for British American Tobacco (BATS) following the company's brief trading update, despite a strong negative stock market reaction yesterday which took the share price down to £31.77. We continue to believe there is significant upside to tobacco valuations. Following the steep sell-off in BAT this year, we are constructive on the stock, which has a five-star rating from Morningstar and a wide economic moat, or strong competitive advantage.

We believe the three most significant items from BAT's update are: 1) next generation product sales such as vaping and heated tobacco are now expected to undershoot previous expectations, and the company is now guiding to £900m in revenue this year, down from the previous guidance of £1 billion; 2) currency is weighing on reported performance and 3) the recent double-digit earnings growth trend remains intact in the short term.

Japan Market Share Increasing

If the downward revision of next generation product revenue had been because BAT was losing share, we would have been concerned, but the firm's heated tobacco share has edged upward in Japan over the course of the year, and now sits at over 4%, and the revenue miss will probably be to the benefit of revenue in the combustible business, which has been cannibalised by heated tobacco growth.

We believe margins in next generation products are much lower than in combustible cigarettes, particularly in vaping, so a slower mix shift to the lower margin portfolio should be positive for EBIT and earnings growth, in our view.

We also retain our slightly below consensus estimate of £2.64 in earnings per share this year. Commentary that the combustibles business remains healthy is encouraging, and broadly in line with our assumptions. We do not assume, however, that BAT can sustain double-digit earnings growth for much longer, however, and we expect a slowdown in the outer years of our forecast period as lower-margin next generation products become a larger proportion of the portfolio mix, fewer efficiency opportunities arise, and interest rates rise.


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 PLC2,346.00 GBX-0.59Rating

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Philip Gorham  

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