Fat Prophets

British American Tobacco

Providing new highs

Tobacco giant British American Tobacco (LSE, BATS) for one has recently reached all time share price highs and looking at recent results it is not difficult to see why.  In a recession dominated year in which top line growth was a very rare commodity, the company managed to boost revenues by 17%, ramp up pre tax profits by almost 11% and increase its dividend payout by 19%.

BAT’s top line came in at £14.2 billion with various factors underpinning the result. Favourable exchange rate movements played a part, as did continued good pricing momentum, and the additional volume brought from 2008 acquisitions of Skandinavisk Tobakskompagni (Denmark) and Tekel (Turkey) and the purchase of Indonesia’s Bentoel Internasional Investama Tbk in June last year.

Whilst management can not control currency moves, they are responsible for the improvement in other areas. Stripping out the currency effects, revenue surged ahead by 10% - no mean feat given the year that 2009 was.

It was not all plain sailing however and group organic sales volumes did fall - by 3% - showing that tobacco is ‘recession resilient’ rather than recession proof. Management though successfully rolled out an 8% increase in prices to make sure cash generation remained robust… a useful tactic; particularly effective when your product is highly addictive.
 
When assessing the BAT’s credentials it is impossible to avoid comparisons with fellow heavyweight Philip Morris International. Morris, which owns Marlboro the supposed preferred brand of the still smoking US President Barrack Obama, posted organic sales growth for 2009 of 0.4%, favourable performance when compared to BAT.

The company also announced a US$12 billion share buyback plan which will no doubt please investors whilst BAT has placed its own buyback plan on the backburner. Before BAT investors begin looking over at their Philip Morris counterparts with envy, we do not see this as a negative. Management at BAT are simply wishing to keep their powder dry in light of further acquisitions whilst maintaining balance sheet strength.

For investors focused on UK listed entities, it is also useful to compare BATS with Imperial Tobacco.  BAT trades on the higher forward price earnings ratio (13.2 Vs 11.4) and in our opinion it is not difficult to see why investors are prepared to pay more for BAT’s earnings. Although we are far from bearish on Imperial Tobacco, BAT’s has the edge on balance sheet strength.  Gearing levels are lower, whilst interest cover and cash levels are higher. BAT shares also offer a better yield - 5.05% Vs 4.12%.

Another factor which attracts investors to BAT is geographic exposure. Over 80% of Imperial revenues are derived from Europe which presently can hardly be described as a hotbed of economic optimism. BAT on the other hand has significant exposure to Latin America, Asia Pacific and Africa and the Middle East which are all significant growth areas.

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