Solid 2H for British American Tobacco, but Volume Decline Rate May Become a Concern

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.

The full-year total combustible decline of 4.2% was slightly below our forecasts, but exactly in line with the decline in the first half of the year. BAT now has one of the broadest platforms across nicotine products, comprising cigarettes, heated tobacco, vaping, and traditional and modern oral products, and it was the new categories that rescued the volume number last year. Cigarette volume declined by 5.0%, while heated tobacco (up 25.6%) and modern oral (up 21.7%) captured some of the migration to alternative products. Price/mix was generally very strong in 2022, with 17% in Europe and 12.7% in the U.S., according to our estimates. Slightly higher revenue growth in the U.S. of 8.1% helped operating profit marginally exceed our forecast, and the operating margin, adjusted for currency movements, was up 90 basis points, slightly better than we had expected and implying margin improvement in the second half of the year.