Is the British American Tobacco (BATS) share price too cheap?

The British American Tobacco (BATS) share price continues to fall despite rising profits. Zaven Boyrazian asks is this a buying opportunity?

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The British American Tobacco (LSE:BATS) share price had a bit of a rough journey throughout 2020. Overall, it fell by 20% last year, despite operating profits actually increasing. And while the stock has since moved up slightly, it’s still trading firmly below pre-pandemic levels. So, is this a buying opportunity for my portfolio?

The falling British American Tobacco share price

In 2020 there were rightful concerns about the firm’s ability to continue selling its tobacco-based products when consumer spending was falling rapidly. Fortunately, these fears proved to be unfounded. Why? Because British American Tobacco’s products are pretty popular with its customers. And so overall revenue in 2020 remained basically flat. But due to operational efficiency improvements, margins increased, leading to a 10.5% rise in underlying profits.

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This is undoubtedly good news. And is why the management team was able to increase shareholder dividends last year. By contrast, most other businesses were either cutting. or outright cancelling, them. So why’s the BATS share price still slumping?

Last week, a report came out indicating the Biden administration is exploring the potential introduction of nicotine level restrictions in cigarettes. The motive behind this move is to further protect the health of smokers. But given that nicotine is what makes cigarettes so popular, it isn’t good news for companies like British American Tobacco.

So far, the US Food & Drug Administration (FDA), who regulates these products, hasn’t made any comments regarding the report. And it’s entirely possible these new restrictions won’t come into effect. But the uncertainty appears to be negatively impacting the BATS share price, for now.

Looking to the future

I believe tobacco-based products will always face a strict regulatory environment that’ll continue to pose a threat in the future. However, the management team has fully acknowledged this risk and has since begun to diversify its portfolio of products. The firm is already seeing a rise in popularity of alternatives to cigarettes, such as vaping devices. It’s even started investing some of its capital into the cannabis sector.

As it stands, these alternative products contribute very little to the top line. But the management team is expecting them to represent around 20% of the revenue stream by 2025.

The British American Tobacco BATS share price has its risks

The bottom line

Seeing a company adapt to changing consumer habits is always a good sign, in my eyes. However, its alternative products are still surrounded by tight regulation at this stage, especially its foray into the cannabis sector.

As it stands, the substance remains illegal for non-medical uses in both the UK and most States in the US. The decriminalisation of marijuana will be an essential requirement to succeed within this space. And while there are expectations of this happening, it’s currently unclear when that might be.

Having said that, based on the current performance and the BATS share price, the 7.8% dividend yield looks very attractive, as well as maintainable. And so, personally, I think this is a buying opportunity for my income portfolio, despite the risks.

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Zaven Boyrazian does not own shares in British American Tobacco. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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