BATS plans £2bn share buyback

British American Tobacco (BATS) is changing direction - or at least giving that impression. In its full year results, the cigarette giant declared that ESG is now “at the heart of its strategy” and that it is successfully reducing the “health impact” of its business. 

Its numbers are less convincing. Traditional cigarettes still dominate BATS' accounts, and emerging markets have driven up combustible revenue by 4 per cent at constant currency rates. South Africa - which temporarily banned tobacco sales during the pandemic - has seen particularly strong cigarette volume growth, together with Pakistan, Bangladesh and Vietnam. In contrast, in 2021 just 12 per cent of group sales came from 'non-combustibles', such as vapes, tobacco heating sticks and nicotine patches, though that's up by 4 percentage points since 2017. 

In the longer term, however, demand for traditional tobacco products is expected to fall, and BATS is keen to mitigate its decline. While the group’s ‘new category’ products are still making a loss of around £100mn, they are becoming more popular. 18.3mn consumers bought non-combustible products in 2021, up from 13.5mn the year before. Meanwhile, revenue from BATs’ new categories shot up by 42 per cent year-on-year to £2.1bn.

The company said its new categories have a “clear pathway to profitability by 2025”, funded - in true ESG style - by “continued strong value growth from combustibles”. In 2021, it further increased new category investment by £496mn.

Putting aside ESG concerns, BATS is a prodigious cash generator that generously rewards its shareholders. Alongside its full-year results, the group has announced a scheme to buy back up to £2bn of ordinary shares. The programme will commence on 14 February and will end no later than 31 December 2022.

Dividends are also on the rise. BATS has increased its pay-outs for over 20 years, and 2021 was no exception, with the dividend edging up by 1 per cent. (The subsequent dip in share price hints that investors were expecting a bigger rise). Meanwhile, the company expects to generate around £40bn of free cash flow over the next five years, suggesting that investors will continue to reap rewards as it ploughs ahead with non-combustibles.

Strong cash conversion has also enabled the group to reduce its net debt by 10 per cent year-on-year. Net debt to adjusted Ebitda now sits at 3x, down from 3.3x in 2020.

Ethical concerns will always dog BATS, regardless of its ESG claims. Even given secular trends, income seekers have much to gain and, with a forward price to earnings ratio of around 11, it's cheaper than many of its tobacco rivals. Hold. 

Last IC view: Hold, 2,767p, 28 Jul