Company Reports

The advent of e-cigarettes has created the most significant change in the tobacco industry since the 1960s. Early forms of e-cigarettes have existed for a generation, but with the consumer arguably less brand-loyal and more aware of health issues than ever before, the industry is undergoing a shift to next-generation nicotine-based products. It seems likely that cigarettes will remain the driving force of the industry profit pool for the next decade, but Big Tobacco manufacturers are nevertheless placing their bets on new categories most likely to win share of smokers.

The advent of e-cigarettes has created the most significant change in the tobacco industry since the 1960s. Early forms of e-cigarettes have existed for a generation, but with the consumer arguably less brand-loyal and more aware of health issues than ever before, the industry is undergoing a shift to next-generation nicotine-based products. It seems likely that cigarettes will remain the driving force of the industry profit pool for the next decade, but Big Tobacco manufacturers are nevertheless placing their bets on new categories most likely to win share of smokers.

Our thesis on British American Tobacco is that while the stock is materially undervalued, the company needs to sharpen its operational focus to accelerate internal cash flow generation and implement a clear capital allocation strategy, whether that is to return capital to shareholders or to scale its investments in some of the emerging nicotine categories. Preliminary 2023 results were slightly below our forecasts, but BAT's announcement that it will consider partially liquidating its stake in ITC is an encouraging step in the direction of improving shareholder returns, in our opinion. We are reiterating our wide moat rating and our GBX 3,900 fair value estimate. Even after the stock gapped up in trading after the announcement, there is significant upside to our valuation, and we are warming to the idea that new CEO Tadeu Marroco's operational and capital allocation strategies could unlock that upside.

British American Tobacco, or BAT, announced it will record an impairment charge of GBP 25 billion on its acquired U.S. cigarette brands in its full-year financial statements. The market is reacting negatively, with BAT's London-traded stock down 9% in afternoon trading on Dec. 6, but we see no reason to alter our wide moat rating or our GBX 3,900 fair value estimate because we feel our valuation already reflects an appropriate decline rate in cigarettes. Although we think the market is greatly undervaluing BAT's future cash flows, we prefer the strategies of some of BAT's competitors to either invest behind the largest substitute profit pools or to manage the cigarette decline for cash and maximize returns to shareholders. We believe BAT is doing neither effectively, but the impairment charge announcement might be a small step in the right direction.

The advent of e-cigarettes has created the most significant change in the tobacco industry since the 1960s. Early forms of e-cigarettes have existed for a generation, but with the consumer arguably less brand-loyal and more aware of health issues than ever before, the industry is undergoing a shift to next-generation nicotine-based products. It seems likely that cigarettes will remain the driving force of the industry profit pool for the next decade, but Big Tobacco manufacturers are nevertheless placing their bets on new categories most likely to win share of smokers.

British American Tobacco reported an encouraging performance in the first half of 2023, with year-over-year organic revenue growth of 2.6%, slightly better than our forecast. The positive news was an improved performance in the New Categories portfolio, although we remain skeptical about the durability of current levels of growth. On the other hand, and as expected, volume in the U.S. market was weak, implying a negative read-through for Altria's second-quarter results. We believe this is a cyclical impact of high food and fuel prices in the United States, and assuming limited change in the employment rate, we continue to believe the market will rebound going into next year. Although we prefer the portfolio of Philip Morris International, we believe BAT's challenges are more than fully priced in and that the market price presents a defensive investment at an attractive valuation. We retain our GBX 3,900 fair value estimate and wide economic moat rating.

The advent of e-cigarettes has created the most significant change in the tobacco industry since the 1960s. Early forms of e-cigarettes have existed for a generation, but with the consumer arguably less brand-loyal and more aware of health issues than ever before, the industry is undergoing a shift to next-generation products. It seems likely that cigarettes will remain the driving force of the industry profit pool for the next decade, but Big Tobacco manufacturers are nevertheless placing their bets on new categories most likely to win share of smokers.

British American Tobacco, or BAT, reported slightly better preliminary 2022 results than we had forecast, thanks to slightly lower price elasticity in Europe than we had anticipated. Broadly, price increases were higher and volume worse than both competitors, notably Philip Morris International, or PMI, and our forecasts, but outside of Europe, price elasticity remained in line with our expectations. We are reiterating our GBX 3,900 fair value estimate of the ordinary shares, and although we think there is valuation upside to BAT, we have concerns that the business will be caught between a rock and a hard place in its drive to overhaul its portfolio while maintaining high levels of capital returns to shareholders.

British American Tobacco reported first-half results that were broadly in line with our forecasts, and we are retaining our GBX 3,900 fair value estimate of the ordinary shares. After being in the doldrums since 2018, BAT and the tobacco group more broadly have outperformed the market significantly in 2022, with BAT up 23% as at the close of business on August 17, and the defensive nature of the tobacco business was clear in these results. The shares still offer modest upside, in our view, and with a current dividend yield of 6.7%, total returns could be fairly attractive in the medium term.

The advent of e-cigarettes has created the most significant change in the industry since the 1960s. Early forms of e-cigarettes have existed for a generation, but with the consumer arguably less brand-loyal and more aware of health issues than ever before, the industry is on the cusp of a seismic shift to next-generation products. It seems likely that conventional tobacco will remain the driving force of the industry profit pool for at least the next decade, but Big Tobacco manufacturers are nevertheless placing their bets on the new categories most likely to win share of smokers.

We have updated our cash flow forecasts and valuations of our tobacco coverage following the announcement from several leading cigarette manufacturers that they intend to change their strategy in the Russian Federation in light of sanctions imposed by the west. While we consider events to be materially negative to cash flows at least in the short term, we think the market has overstated the valuation impacts. We are lowering our valuation of Philip Morris International (PMI) to $103 from $108, and of British American (BAT) to GBX 3,900 from GBX 4,000.

The advent of e-cigarettes has created the most significant change in the industry since the 1960s. Early forms of e-cigarettes have existed for a generation, but with the consumer arguably less brand-loyal and more aware of health issues than ever before, the industry is on the cusp of a seismic shift to next-generation products. It seems likely that conventional tobacco will remain the driving force of the industry profit pool for at least the next decade, but Big Tobacco manufacturers are nevertheless placing their bets on the new categories most likely to win share of smokers.

There were few surprises in British American Tobacco's, or BAT's, preliminary 2021 results, with most financial metrics bang in line with our expectations. We are reiterating our wide moat rating and GBX 4,000 fair value estimate for the ordinary shares. Tobacco stocks have staged something of a recovery amid concerns around inflation, and the company is no longer as mispriced as it was three months ago. The strong pricing power demonstrated in these results supports our view that tobacco will remain a safe haven for investors worried about the sustainability of corporate earnings.

British American Tobacco reported in line results for first-half 2021. Both revenue and margins were in line with our forecasts, and we are reiterating our GBX 4,000 fair value estimate for the ordinary shares. The report was most remarkable for a step-up in growth in the new category business and for strong execution on the Quantum cost savings programme.

We think the market is right to brush off the judgement in the U.S. by an International Trade Commission, or ITC, administrative judge in favor of British American Tobacco in a patent dispute with Philip Morris International. The dispute surrounds the technology that heats tobacco leaf to a temperature at which a nicotine aerosol is created, but below the point at which combustion takes place, thereby reducing smokers' exposure to the carcinogens found in cigarettes. The worst case scenario for PMI (and best case for BAT) is that imports of iQOS devices into the U.S. are prohibited, but we think advances in the technology will ensure that any such ban would have very limited strategic and financial impact for PMI, and its partner in the commercialization of iQOS, Altria, and PMI remains our quality pick in the undervalued tobacco sector.

The advent of e-cigarettes has created the most significant change in the industry since the 1960s. Early forms of e-cigarettes have existed for a generation, but with the consumer arguably less brand-loyal and more aware of health issues than ever before, the industry is on the cusp of a seismic shift to next-generation products. It seems likely that conventional tobacco will remain the driving force of the industry profit pool for at least the next decade, but Big Tobacco manufacturers are nevertheless placing their bets on the new categories most likely to win share of smokers.

The advent of e-cigarettes has created the most significant change in the industry since the 1960s. Early forms of e-cigarettes have existed for a generation, but with the consumer arguably less brand-loyal and more aware of health issues than ever before, the industry is on the cusp of a seismic shift to next-generation products. It seems likely that conventional tobacco will remain the driving force of the industry profit pool for at least the next decade, but Big Tobacco manufacturers are nevertheless placing their bets on the new categories most likely to win share of smokers.

British American Tobacco reported full-year 2020 results essentially in line with our forecasts. We are reiterating our GBX 4,300 fair value estimate and wide moat rating. The stock remains materially undervalued, in our opinion, but a disparity is emerging in the long-term outlook between Philip Morris International, which dominates the heated tobacco category, and its competitors. While we think the cash flows from the core cigarette business are being underappreciated, we would prefer to see a bolder vision for migrating consumers to next generation products.

British American Tobacco, or BAT, disclosed in a preclose trading update that the first half is tracking more or less in line with our expectations. The only surprise was a slightly stronger performance in the United States, where BAT has taken share. Emerging markets appear to be very challenged, however, and we are tweaking our estimates lower to account for the potential of a temporarily higher cessation rate in certain markets. Accordingly, we are lowering our fair value estimate to GBX 4,300 from GBX 4,500. Nevertheless, we continue to see significant upside to BAT and in tobacco generally, and we think both the wide moat rating and business model remain intact.

The advent of e-cigarettes has created the most significant change in the industry since the 1960s. Early forms of e-cigarettes have existed for a generation, but with the consumer arguably less brand-loyal and more aware of health issues than ever before, the industry is on the cusp of a seismic shift to next-generation products. It seems likely that conventional tobacco will remain the driving force of the industry profit pool for at least the next decade, but Big Tobacco manufacturers are nevertheless placing their bets on the new categories most likely to win share of smokers.