Shares in FTSE tobacco and nicotine products manufacturer British American Tobacco (LSE: BATS) are down 32% from this year’s high.
News on 6 December of a £25bn one-off impairment charge on some of its US cigarette brands did not help.
However, I think this business shock – attributed to economic headwinds damaging sales in its biggest market – may benefit the company long term.
It could spur on its strategy to derive half of its revenues from non-combustible products, such as vapes, by 2035.
The major risk in the shares, in my view, is that the timing of this switch away from tobacco products slips.
However, if it does not then the refocusing of its core business looks very positive, in my view. As is the company’s cheap share valuation compared to its peers, and the big dividend payments it makes.
Core business refocusing
The recent huge valuation write-down in some of its key tobacco brands underlined the fragility of that market to me.
However, there were positives in the 6 December statement as well. The key one in my view was that its ‘New Categories’ non-combustible products will be profitable from 2024 onwards. This is two years ahead of schedule, according to the firm.
The three key products – Vuse vapes, Velo oral pouches, and Glo tobacco heaters – now generate more than £3bn in revenue.
Overall, the company projects low-single-digit revenue growth and adjusted profits next year. It then projects 3%-5% revenue growth and mid-single-digit profit growth by 2026.
Undervalued compared to its peers
On a price-to-earnings (P/E) basis, the company is the cheapest in its peer group, trading at 5.9.
Imperial Brands is at 6.7, Altria Group at 8.4, and Philip Morris International at 18. This gives a peer group average of 11.03.
To determine what a fair price for the company’s shares might be, I applied the discounted cash flow (DCF) model, using several analysts’ valuations and my own.
The core assessments for the company range between 63% and 66% undervalued. The lowest of these would give a fair value per share of £62.00 compared to the current £22.94.
This suggests to me that the shares are very good value indeed, even if there is no guarantee that they will ever reach that higher price.
Big dividend payer
In 2022, the company paid a total dividend of 217.8p per share. Based on the current share price, this gives a yield of 9.5%.
This year, all four dividend instalments have now been declared, totalling 230.885p. On the current share price, this would yield 10%.
This is one of the very highest payouts in the FTSE 100. It also means that if the yield averaged the same over 10 years, an investor would double their initial investment.
Yields change frequently, of course, because of share price moves and changing dividend payments. There would also be tax implications to consider, based on individual circumstances.
Having never held the stock, I am seriously considering buying it for three reasons.
First, it trades at very cheap valuations, so I think the share price will rise over the next few years.
Second, and contributing to this rise, is the company’s long-term business refocusing strategy.
And third, I believe there is every chance that it will maintain high dividend payments in the future.
