Why British American Tobacco plc’s Investment Strategy Should Blast Earnings Higher

Royston Wild evaluates what British American Tobacco plc’s (LON: BATS) capex drive is likely to mean for future earnings.

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Today I am looking at why I believe British American Tobacco‘s (LSE: BATS) (NYSE: BTI.US) expenditure plans into high-growth markets should underpin solid long-term growth.

Rising emerging market exposure to drive growth

In previous years British American Tobacco had focused acquisition activity towards gearing up its exposure to developing markets, home to the lion’s share of the world’s smokers. Previous transactions include the takeover of Turkey’s Tekel and Bentoel of Indonesia, and the latest such takeover saw the firm buy Protabaco — Colombia’s second-biggest cigarette firm — for $452m in 2011.

Even though takeovers have slowed recently, emerging markets remain very much on British American Tobacco’s radar. Last July the companybritish american tobacco / imperial tobacco set up a joint venture in Myanmar with IMU Enterprise to manufacture, distribute and market the Group’s brands. The firm has also hiked its stake in its British American Tobacco Bangladesh subsidiary to 73% in recent times, one of the company’s outstanding markets.

Indeed, the firm’s aggressive expansion in these regions helps to mitigate against ongoing trading difficulties in the West. Despite a multitude of local market difficulties, British American Tobacco still saw volumes and profits from Asia Pacific — the company’s joint largest market — rise 7% and 2% respectively during 2013.

But British American Tobacco is also investing vast sums into the white-hot e-cigarette market, and in December 2013 acquired CN Creative, a market leader in the research and development of the technology, for a fee rumoured to be up to £50m. ‘E-cigs’ are viewed by many as the next great growth driver for the tobacco industry, and analysts at Wells Fargo put 2013 sales of the products at $1bn, up from $300m just two years earlier.

British American Tobacco was the first entrant onto the scene with the launch of its Vype product last December. But with the world’s other big-cap tobacco plays also entering the arena in the coming months, the company is likely to continue chucking vast amounts of capital at this high-growth market.

Earnings bounceback anticipated from 2015

Still, in the meantime a backcloth of stagnating demand for traditional cigarettes is likely to crimp earnings growth. City analysts expect earnings to remain flat in 2014 before surging 8% higher next year.

Undoubtedly concerns over pressure on consumers’ wallets, combined with rising anti-smoking legislation across the globe, has dented confidence in the tobacco sector in recent times. But in my opinion British American Tobacco’s investment focus on emerging markets, not to mention the huge growth area of e-cigarettes, should propel earnings skywards in coming years.

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.

Royston does not own shares in British American Tobacco.

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