- Objective of the Analysis
The objective of the financial analysis is to identify sound entities for long-term investment purposes.
For the purposes of this analysis I will have a look at the following:
- An overview of the operations
- Management
- Strategic drivers and key success factors
- Outlook
- Financial information
- Background
British American Tobacco operates in the North and South Americas, Europe, Africa and in the Asia Pacific areas with more than 200 brands in their portfolio.
- Management
The board of directors have an impressive array of qualifications and experience.
- Strategic Drivers
This is not defined in the interim financials, but one can assume it will relate to cigarettes, combustibles (vapours and THP), oral (both modern and traditional) and the well-known brands.
With brands stretching over generations, this can only add to the success of the Group. Further, new brands are formulated on an ongoing basis to serve the market needs on a global scale.
- Risks
5.1. Management
The risks management identified are as follow:
Competition from illicit trade
Tobacco, nicotine and other regulations inhibits growth
Market size reducing and consumer down trading
Litigation
Geopolitical tensions
Disputed taxes, penalties and interest
Significant increases or structural changes in taxes
Foreign exchange exposures
Injury, illness or death at workplace
Solvency and liquidity
Inability to develop, roll-out and commercialize Potentially Reduced-Risk Products
5.2. Key Audit Matters
The financial were not audited.
5.3. Other / General
Risk of poor investment decisions
Loss of missed opportunities
Adverse market changes
Imposition of adverse compliance regulations
Commercial objectives not attained
Unforeseen liabilities arising from changes in the portfolio
Sales revenue and operational performance not meeting expectations
Anticipated synergies and cost savings not been achieved or delayed
Inability to retain key staff
Unforeseen catastrophes
Cybersecurity risks
Cost pressures and reduction in productivity
Safety and health risks
- Outlook
Moody’s and Standard and Poor’s grading for the Group is a “stable outlook”.
The financials are silent about the expectations, other than the financial obligations will be met in future.
The USA is the biggest market for the Group, with a substantial annual growth in revenue due to the take-over.
Brexit does put a damper on the growth outlook of Europe, perhaps the reason why Western Europe is now combined with North Africa.
- Analysis of financial information
- Segmental information
BATS uses the following segmental information:
- USA
- APME or Asia Pacific and Middle-East
- AMSSA or Americas and Sub-Saharan Africa
- ENA or Europe and North Africa
During the 2017 financial year, BATS took over an American tobacco company, hence the reason why the sales in the USA segment rose from £4,6m to £9,5m (duties and excise taxes excluded). This also influences the margins favourably.
The growth in sales in the Americas were good.
The overall impression is positive: Sound margins with certain segments posting remarkable growth figures.
- Liquidity ratios
The liquidity ratios are under pressure and this is reason for concern.
- Leverage ratios
The debt levels are high very high, with a net interest cover of 2,1 (2017 – 1,7).
Cash from operations over liabilities is a modest 12,8% (2017 – 6,7%).
The reason for these high debt levels influencing the Liquidity and Leverage ratios negatively, is most probably the fact the take-over was done with too much emphasis on debt financing.
- Activity ratios
Both the stock turnover and debtors collection periods have decline, which is positive. However, the time it takes to pay creditors is very long.
The Group has invested heavily into Intangible Assets, some £124 013m (2017 – £117 785 m).
- Profitability ratios
The Group does not report a “Cost of Sales” figure, but if the changes in inventories are taken with raw materials consumed, with depreciation and employee costs in order to calculate a “Rule of the thumb” gross profit, then the GP % amounts to 25,2% (2017 – 20,1%). The net profit margin of 14,8% (2017 – 11,2%), both ratios are good.
The growth in sales amounted to 9% (2017 – 24%) while the expenses increased with 25% (2017 – 46%) during the year under review.
- Cash flow
The operating cash flow in relation to total liabilities amounts to 12,8% (2017 – 6,7%), which is low taking the amount of debt into consideration.
- JSE Statistics
The share price grew with 2,4% over the last five years, dropped with 32,3% over the last three years and dropped with 10,0% over the last year.
The consensus forecast amongst financial analysts is a: “Buy”.
The EPS is 4762c, the P/E ratio is 12, the forward P/E is 9 and the dividend yield is 5,9%.
- Conclusion
BATS invested heavily into intangible assets as part of the take-over in 2017 when the Intangible assets grew from £12 117m to £117 785m. In order to finance this transaction extensive use of debt was made and this influences the Group to today. It further seems as if the Group has difficulty in bringing these debt levels down.
A further concern is the ability of the Group to contain costs: Operating expenses grew with 25% (2017 – 46%).
The margins are good and there are signs of growth in sales, although it operates in a saturated market.
In view of the fact that both Moody’s and S&P has given the Group a sound rating, and in view of the sound margins, this might to a certain degree mitigate the risks associated with the high debt levels.
The total debt levels in comparison to a Group such as Anheuser=Busch Indev is more favourable, however the price of the shares at a P/E ratio of 12 is relatively cheap.
In view of the above, I will rate BATS as a buy, but it should be carefully monitored.
Anton Ferreira
25 March 2019