British American Tobacco pauses share buybacks

British American Tobacco (BATS) shares fell by 5 per cent after the market took fright at the cigarette giant’s pausing of share buybacks, which are a key attraction for investors in the tobacco sector as environmental, social and governance (ESG) concerns otherwise impact sentiment. Even a 6 per cent hike in the dividend couldn’t prevent the markdown, as the board focuses its attention on reducing leverage more quickly to the middle of its two to three times net debt to cash profits target range. 

As RBC Capital Markets analysts point out, “investors’ focus on British American Tobacco will be less on the results, or even the outlook... and more on the share buyback” position. Bad news for management, especially as there were some positive signs for investors to mull over.   

The performance of the company’s ‘new category’ division, which includes vapour products, was a highlight. Like tobacco peers, one of the ways the company is responding to ESG concerns is by pushing non-traditional products as part of a goal “to reduce tobacco harm”. A tough ask, given that the vast majority of its revenues come from traditional products, and there are still serious concerns around addiction and health with new creations. 

New category revenues were up by 41 per cent to almost £3bn in the year, and profitability is now expected in 2024, a year ahead of plan. The company is targeting £5bn of new category sales by 2025 and 50mn customers by 2030. While this is promising, the category still only represents a small part of the business, taking 10 per cent of total revenues.  

Overall revenue growth was also helped by higher prices. But volumes are struggling. The company’s volume share fell by 10 basis points in the year, and it expects global tobacco industry volumes to fall by 2 per cent in 2023. And despite a 10 basis point rise in share in the US, its global value share was flat. 

Cost savings, key in this inflationary environment, are providing a boost. Annualised savings of £1.9bn were significantly ahead of target, and £629mn of savings in 2022 helped the adjusted operating margin rise by 90 basis points. Elsewhere, the key operating cash conversion metric (important for funding the return of capital) came in ahead of target at 100 per cent. 

While the secular decline in traditional tobacco use is the key bear point facing the company, progress is being made with new category products, albeit the situation is nuanced. And the valuation remains attractive, with a forward price/earnings ratio of eight times according to the FactSet consensus, below the five-year average. But tobacco investors should wait for further buyback news. Hold.

Last IC view: Buy, 3,459p, 27 Jul 2022