British American Tobacco - Smoking stock price

Investors in British American Tobacco (LSE, BATS) might well be wondering if the stock is immune to market volatility with it having moved in an upward channel since mid-2009. The stock has been on an impressive run with a gain of over 50% since the start of 2010, impressively managing to maintain the momentum as the stock has continued to re-rate relative to earnings (i.e. the P/E ratio has increased).

Looking at 2011 performance and organic and reported cigarette volumes fell by 0.4% which was a good performance in comparison to the 2% fall in volumes in 2010.  Within this, BATS’ “Global Drive Brands” (GDR) – these include Pall Mall, Lucky Strike, Dunhill and Kent – saw a volume increase of 9% vs. an increase of 7% in 2010.

Thus overall volume declines for BATS have moderated and the key premium brands have seen robust growth.  A key driver was the 2% volume growth in the Asia Pacific region which offset a 5% contraction in the Americas – this highlights the benefits of the emerging market exposure.

Turning to revenues and the strength of high priced premium brands, together with the ability to push through price increases, generated a total revenue jump of 7% at constant exchange rates despite the fall in volumes. 

For any business top-line growth is critical for long-term profits growth as costs can only be cut so much.  However, BATS is still making headway with costs with the operating margin in 2011 improved to 35.8% from 33.5% in 2010.  This allowed BATS to achieve its 35% margin target a year ahead of schedule and going forward 50 to 100 basis points improvements are targeted every year. 

Taken together the margin and revenue improvements generated a 10% increase in profits on a constant currency basis and an 11% improvement at current exchange rates.  Asia Pacific became the largest profit generator as a region overtaking the Americas.

Translating the figures into earnings per share growth and this also came in at an 11% gain with a boost of 1% driven by share buy-backs during the year.  Thus EPS in 2011 came in at 194.6p against 175.7p in 2010.  The BATS formula saw flat cigarette volumes being turned around into strong profits growth.

There looks to be further for this formula to run as “Global Drive Brands” see market share gains (boosting margins), costs are taken out, acquisitions continue to be made and stock buybacks increase.  At the same time recovering economies suggest that cigarette volumes are seeing smaller declines and may even see growth on emerging markets.

Looking at the stock buy-back and this was a key feature of the full year results with 28m shares bought back in 2011 at a cost of £750m.  A continuation of the scheme with a value of £1.25bn has been agreed by the company’s Board which will support the shares.

BATS noted that in the second half of 2011 the group has seen recovery signs in its key markets while pricing momentum has continued.  The strong position of the company in emerging markets bodes well for the longer-term while the strong brands of the group offering good prospects for margin growth.

This article was produced by Senior Research Analyst Andrew Latto.