How British American Tobacco Plc Is Changing

What does the future hold for investors in British American Tobacco Plc (LON:BATS)?

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Successful companies don’t stand still. They’re always evolving. Today, I’m looking at the changes taking place at FTSE 100 tobacco giant British American Tobacco (LSE: BATS) (NYSE: BTI.US) — and what they mean for investors.

Volumes

The volume of tobacco-industry sales in developed countries has been declining year-on-year, and is set to continue doing so as health awareness and regulatory measures, such as plain packaging, increase. At the same time, volume growth in emerging markets is widely predicted to continue for many years to come, driven by simple population growth and increasing disposable income.

british american tobacco / imperial tobaccoFor 2013, British American Tobacco (BAT) reported total volumes down 2.6%, with contraction in Western Europe particularly marked (-8%), but good growth in Asia (+5%). Despite the overall decline in volumes, group revenue actually increased 4% (at constant exchange rates); in other words, while BAT sold fewer sticks, it was able to charge more for each stick it sold.

Global Drive Brands

While BAT has a portfolio of over 200 brands, its four ‘Global Drive Brands’ (GDBs) — Dunhill, Kent, Lucky Strike and Pall Mall — account for 35% of volumes (up from 26% five years ago). Investing behind these key brands has meant that collectively they have continued to increase volumes (+1.9% during 2013), helping mitigate the overall volume decline.

BAT has this year announced a change to the GDB portfolio: Rothmans is to be promoted as a fifth member of the elite. Upping investment in this brand should further help volumes.

New markets and new products

Despite BAT’s brands being sold in around 180 markets, the company is still seeing new opportunities in new geographies (presumably high-growth emerging countries) and is ’embracing’ these.

Also, the group is beginning to develop next-generation tobacco products, such as heat-not-burn, as well as nicotine-based products, such as electronic cigarettes. In fact, BAT has recently launched Vype, its first e-cigarette, in the UK, making it the first international tobacco business to enter this new market.

BAT’s chief executive reckons it’s far too early to predict how the market will develop, but that there’s potential for high margins, and he wants to be at the forefront if this product category does take off.

Looking to the future

The promotion of Rothmans to the GDB portfolio and expansion into as-yet-untapped territories should help tobacco volumes; but volumes aren’t the whole story of BAT’s future.

As we saw last year, BAT was able to increase revenue, despite a year of lower volumes, due to the pricing power that comes with being a producer of an addictive consumer product. BAT is also working “to address our cost base, to standardise our systems and deliver productivity savings year on year”. Thus, we saw a 1% improvement in operating margin during 2013. Management is targeting further sustainable margin expansion.

Putting it all together, while investors won’t see the double-digit earnings growth of the Noughties, BAT reckons that high single-digit growth is do-able going forward.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

G A Chester does not own any shares mentioned in this article.

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