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British American Tobacco (NYSE:BTI) ended fiscal 2022 with strong growth in its non-combustible product category, putting the tobacco company on track to achieve profitability in fiscal 2024. In addition alternative products such as Vuse and Velo have strong revenue and volume momentum. , the firm currently offers dividend investors with a 7.2% dividend yield. British American Tobacco also generates a significant amount of free cash flow that supports the dividend and limits downside risks. BTI’s valuation on an earnings basis and the company’s positive business trajectory in new tobacco categories make the stock a very interesting buy for dividend investors. I don’t see any reason for weakness in BTI’s share price and I believe the market has turned too bearish on British American Tobacco in recent months!
Data by YCharts
Momentum continues in alternative product categories
It’s not much of a secret that the share of smokers is in a long-term decline that is deeply affecting the tobacco industry’s earnings prospects. It is therefore a key priority for tobacco companies such as British American Tobacco to develop new product portfolios that accommodate changes in consumer smoking preferences.
Near-term profitability outlook in new product lines
British American Tobacco’s alternative tobacco categories include the three brands Vuse, which are vape products, Glo, which is BTI’s heated tobacco products, and Velo, which are nicotine sachets and lozenges. These alternative nicotine products are seeing strong customer acceptance, especially among youth demographics in key markets such as the US and the UK. As a result, British American Tobacco plans to aggressively grow alternative product revenue to £5.0B ($6.1B) by fiscal 2025, implying an annual average top line growth rate of 20%. British American Tobacco ended fiscal 2022 with alternative product revenue of £2.9B ($3.5B), representing an impressive 41% year-on-year growth rate. As British American Tobacco is aggressively investing in alternative tobacco products as well as marketing, I expect this momentum to continue in fiscal 2023.
Source: British American Tobacco
Vuse and Wello were the two strongest performing brands in British American Tobacco’s new category portfolio in FY2022, as they saw revenue growth of over 40%. Revenue growth was primarily driven by strong customer adoption driven by double-digit volume growth. Vuse, BTI’s vape brand, projects 44% revenue growth in FY2022 and the brand now has a value share of 36% in the US.
Source: British American Tobacco
a clear path to profitability
Heavy investment in alternative tobacco products is starting to pay off for British American Tobacco. The company invested over £2.0B ($2.4B) in the development of its alternative product brands last year and the new category portfolio is set to deliver positive returns in FY2024.
Source: British American Tobacco
effective cost savings program
British American Tobacco has implemented a cost-saving program that initially called for £1.0B ($1.2B) in cost reductions, which the company is expected to exceed in fiscal 2022. Total cost savings of £1.9B ($2.3B) in FY2022 are accelerating BTI’s path to profitability. I believe that reaching profitability in the new product category could be a strong catalyst for share price appreciation.
Source: British American Tobacco
New categories and non-US markets driving growth
British American Tobacco reports 2.3% consolidated revenue growth for FY2022 (in constant currencies), but the majority of this growth occurs in new categories (as just discussed), but not in non-US markets Too. Europe is doing particularly well for British American Tobacco due to the roll-out of alternative products in Scandinavian countries such as Sweden and Norway. New categories see 37% revenue growth in FY2022 (in constant currencies) to £2.9B ($3.5B). The revenue share of the new categories was 10%. Over the long term, I see this revenue share going up to 20% for BTI.
Source: British American Tobacco
Increase in free cash flow support through new category development
BTI has sufficient free cash flow to pay a strong dividend to shareholders. But it is also a potential stabilizing factor that could limit BTI’s downside potential going forward. BTI reported £8.0B ($9.7B) in free cash flow for FY2022, showing a 7% year-on-year improvement. The increase in free cash flow was driven by cost savings, volume gains as well as growth in alternative product revenue.
Source: British American Tobacco
BTI Valuation vs Rivals
British American Tobacco isn’t the cheapest of tobacco sin stocks, but that doesn’t mean BTI isn’t an attractive dividend investment. British American Tobacco expects 3.8% top line growth this year and 5.4% next year. The tobacco company’s stock is currently valued at a P/E ratio of 7.7X, which is at the low end of BTI’s P/E range over the past year. The earnings multiple used here assumes $4.80 per share in earnings in fiscal 2023.
Data by YCharts
Relative to other tobacco companies, I believe that British American Tobacco also compares very favorably: Altria Group (MO) and Philip Morris International (PM) trade at P/E ratios of 9.2X and 17.0X, which BTI making it the cheapest available sin stock. Of earning
Data by YCharts
In regards to dividend yield, British American Tobacco offers the second highest dividend after Altria which currently pays 7.9%. Altria’s yield is solid and covered by adjusted earnings, which is why I recommend MO to dividend investors as well.
Data by YCharts
Risks with BTI
There are certain risk factors that investors looking to invest in sin stocks should take note of. Anti-tobacco regulation remains a major obstacle for British American Tobacco as well as for the industry. A ban on e-cigarette or vape products is also a potential risk for British American Tobacco as it would cut into the growth potential of its alternative product category that is currently driving BTI’s free cash flow and revenue.
final thoughts
The market is wrong in pricing BTI so cheap considering how much free cash flow the firm generates and how solid the new category’s momentum has been in fiscal 2022. British American Tobacco has clear momentum in the alternative products category and could reach profitability in fiscal 2024. A catalyst for the stock. The firm’s strong free cash flow both funds the dividend and supports the share price, which has seen renewed weakness since December. I believe the combination of British American Tobacco’s strong free cash flow, revenue and volume momentum in Vuse and Velo, as well as the low valuation on an earnings basis adds to British American Tobacco’s appeal as a dividend stock going forward Is!
Source: seekingalpha.com
