We came across a bullish thesis on British American Tobacco p.l.c. (BTI) on Deep Value Investing’s Substack by Andrei. In this article, we will summarize the bulls’ thesis on BTI. British American Tobacco p.l.c. (BTI)’s share was trading at $37.94 as of Nov 27th. BTI’s forward P/E was 8.16 respectively according to Yahoo Finance.
Photo by Nafis al Sadnan on Unsplash
British American Tobacco (BTI), a dominant player in the global tobacco industry, has experienced significant challenges recently, highlighted by a notable 40% drop in its stock price from June 2022 to April 2024, far outpacing the S&P 500’s performance. Although the company has shown some recovery, it still lags behind its historical growth, primarily due to a massive $31.5 billion write-down in 2023. This setback has led investors to question whether BTI is a value play or has become an investment burden, especially with a business model transitioning away from traditional tobacco products toward next-generation nicotine products (NGPs) like vapes and pouches.
BTI’s origins trace back to 1902 when it was established as a joint venture between the UK’s Imperial Tobacco Company and the American Tobacco Company. Over the years, the company expanded its footprint, acquiring prominent players in the industry such as the American Tobacco Company in 1994 and Rothmans International in 1999. The company’s global reach includes markets in Canada, China, and South Africa, and more recently, BTI has entered the cannabis sector, acquiring a 20% stake in Canada’s OrganiGram in 2021. However, while BTI’s long-standing history and expansion have positioned it as a key player in the tobacco industry, recent market shifts have slowed growth.
Despite experiencing a compound annual growth rate (CAGR) of 9.6% over the past nine years, driven partly by the Reynolds American acquisition in 2017, BTI’s future growth projections are subdued. The company expects only 2-3% annual growth in the near term, marginally above the inflation rate. Much of this growth will come from its New Generation Products (NGPs), a segment that has seen impressive expansion since its introduction in 2017. With a 42.7% CAGR, NGP revenue reached £3.35 billion in 2023, and BTI projects NGPs will account for 50% of total revenue by 2035. Despite this promising pivot, NGPs generate lower margins than traditional tobacco products, leading to concerns about future profitability as the NGP segment grows.
BTI’s financial health remains relatively robust despite these challenges. The company’s gross margin has improved by over 600 basis points, reaching nearly 83%, and its net income has grown at a 6.5% CAGR over the past decade, with expectations to continue this growth through at least 2025. Strong cash flow generation is another hallmark of BTI’s financial performance, with cash flow from operations (CFFO) increasing at an 11% CAGR over the past nine years. Its free cash flow (FCF) yield of 16.12% also reflects BTI’s ability to generate value for shareholders, even amidst a slowing growth environment. However, the significant write-down in 2023, which resulted in a net loss, has cast a shadow over its profitability.
From an investor’s perspective, BTI still offers an attractive value proposition, particularly for those willing to accept the risks associated with its transition to NGPs. The company’s cash flow and FCF yield remain strong, and its ongoing share buyback program and consistent dividend yield add further shareholder value. However, the stock’s recent performance and the challenges associated with the shift away from traditional tobacco products raise questions about its long-term potential. BTI’s ability to navigate this transition will depend on its success in growing its NGP business while managing regulatory risks, market competition, and ongoing commitment to shareholder returns.
The company’s valuation has been analyzed using several methods, including a discounted cash flow (DCF) analysis, which takes a cautious stance by incorporating low growth assumptions for both the traditional tobacco and NGP segments. This analysis estimates a net present value (NPV) per share of £42.61 ($53.39 USD). Still, given the company’s challenges a reasonable fair value is determined to be $47.03, with an attractive buy range between $30.57 and $37.60.
BTI operates in a highly consolidated market, which affords it significant competitive advantages, including high barriers to entry and strong pricing power. Its brand portfolio, including iconic cigarette brands like Dunhill, Kent, and Lucky Strike, continues to provide stability, while emerging NGPs like Vuse and Glo allow it to tap into changing consumer preferences. However, the growing shift toward e-cigarettes presents risks, particularly due to the fragmented nature of the market, the lack of brand loyalty, and increased competition. Regulatory uncertainty also looms, with concerns over potential advertising, packaging, and product sales restrictions.
BTI remains well-positioned in the long term despite these short-term risks due to its strong cash flow, market dominance, and growing NGP segment. However, investors should remain cautious and consider the broader industry challenges that could impact BTI’s future performance. If the company’s NGP segment continues to outperform expectations, BTI could still provide significant value to investors willing to take a long-term view.
British American Tobacco p.l.c. (BTI) is not on our list of the 31 Most Popular Stocks Among Hedge Funds. As per our database, 24 hedge fund portfolios held BTI at the end of the third quarter which was 21 in the previous quarter. While we acknowledge the risk and potential of BTI as an investment, our conviction lies in the belief that some AI stocks hold greater promise for delivering higher returns, and doing so within a shorter timeframe. If you are looking for an AI stock that is more promising than BTI but that trades at less than 5 times its earnings, check out our report about the cheapest AI stock.
READ NEXT: 8 Best Wide Moat Stocks to Buy Now and 30 Most Important AI Stocks According to BlackRock.
Disclosure: None. This article was originally published at Insider Monkey.