Currency Headwinds Buffet British American Tobacco plc – How Will This Affect Imperial Tobacco Group PLC?

smokingGlobal tobacco giant British American Tobacco (LSE: BATS) published its interim management statement for the nine months ended 30 September 2014 today, and so far, the update has failed to impress the market.

Indeed, even though the company reported revenue growth of 2.4% at constant exchange rates, at current exchange rates revenue slumped by a shocking 9.6%. However, the company did report that the volume of Global Drive Brand cigarettes shipped during the period increased by 6.2%. The overall volume of cigarettes shipped by the company and its subsidiaries decreased by 1%.

But overall, today’s update from British American contained no surprises and was, on the whole, relatively upbeat. The total volume of cigarettes shipped by the group declined from 521bn in the same nine month period in 2013, to 515bn this year, although this was to be expected. The group still expects to deliver another year of good earnings growth at constant rates of exchange.  

Merger mania 

British American continues to rack up a solid rate of organic growth, through price increases and rising sales volumes of the company’s key Global Drive Brands. Nevertheless, over the next 12 months British American is set to benefit from a mega-tobacco-merger that is currently in the works. 

Reynolds American and Lorillard are two of the largest tobacco companies in the US and are currently finalising the terms of a merger. The deal is extremely complex and involves Reynolds, Lorillard, British American and Imperial Tobacco (LSE: IMT).

British American owns around half of Reynolds and has agreed to provide funds for the deal, around $4.7bn in fact. Meanwhile, Imperial has agreed to spend £4.2bn buying unwanted brands from both Reynolds and Lorillard. 

This deal will be a huge boost for Imperial. The company will see its share of the US cigarette market jump from around 3% to 10% and the enlarged U.S. business will be 24% of Imperial’s combined tobacco net revenues.

Currency headwinds

Unfortunately, even though Imperial’s deal with Reynolds and Lorillard will transform the group, it will leave Imperial extremely exposed to currency headwinds. That said, a stronger pound will make the deal cheaper for Imperial, although over the long-term a strong sterling will dent revenue growth and profitability. 

What’s more, just like British American, Imperial is likely to report that currency has taken a significant chunk out of earnings when it reports full-year results later this year. Both Imperial and British American generate most of their sales outside of the UK, so a strong pound will always impact their revenues more than most. 

Still, on an underlying basis City analysts expect that these two tobacco behemoths will continue to grow. Despite currency headwinds analysts expect mid-single-digit earnings growth for both companies every year for the next few years.

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Rupert Hargreaves owns shares of Imperial Tobacco Group. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.