British American Tobacco ponders ITC divestment

British American Tobacco (BATS) indicated in its annual results that it could cut its £14.7bn stake in Indian conglomerate ITC, a move that could speed up the return of share buybacks. Management has “been actively working for some time on completing the regulatory process required to give us the flexibility to monetise some of our shareholding” – good news for investors who are anxiously awaiting buyback news after they were paused as the company tries to get leverage down to the middle of its target range of two to three times adjusted net debt to cash profits.  

The signs are positive on that front, with leverage coming in at 2.6 times in 2023. In the meantime, as investors await further news, they will have to put up with a painful annual loss due to a higher-than-expected £27.3bn impairment charge on the company's acquired US tobacco assets. British American Tobacco forecast in December that it would suffer a charge of around £25bn due to headwinds hitting the US cigarette market. The higher charge highlights the highly uncertain future for cigarette performance in key markets. 

The slight revenue fall was driven by the sale of the company's businesses in Russia and Belarus and an 8.2 per cent fall in cigarette volumes as the secular trend of declining smoking rates continues. The company’s US cigarette volumes were down 11.4 per cent, although its volume share has risen 40 basis points since January last year. Management pinned some of the decline on the spread of illegal single-use vaping products.   

On the plus side, the company posted revenue growth of 15.6 per cent at its new-categories division (which contains vaping, heated, and oral products) which became profitable two years ahead of management’s target. Volumes were up 7 per cent for vaping products and by a third for oral pouches, but fewer heated sticks and oral sticks were sold. Management is working towards a target of deriving 50 per cent of total revenue from these products by 2035. 

British American Tobacco is yet to launch a heated tobacco product (THP) in the US, where the market is dominated by Philip Morris International (US:PM). The two companies reached a settlement earlier this month on patent infringement litigation regarding heated tobacco and vapour products. 

A lowly rating of six times forward consensus earnings highlights the serious ongoing headwinds for this tobacco purveyor. But with the return of buybacks appearing on the horizon, and a chunky dividend yield on offer, it isn't all doom and gloom. Hold. 

Last IC view: Hold, 2,695p, 26 July 2023