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Should you buy British American Tobacco shares on the dip?

British American Tobacco (LSE: BATS) shares are suffering right now, and it might still be premature to invest in BATS fully. The tobacco sector has been hit badly in 2018, and year-to-date BATS is down about 35%.

So what should we expect from British American Tobacco, the world’s second-biggest international tobacco company by revenue, after the year-long collapse of the share price. Here are the pros and the cons to BATS shares.

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Pros for British American Tobacco shares

During 2018 British American Tobacco posted a strong balance sheet, with revenue growth over 50% and strong operating margins. Analysts expect earnings per share (EPS) growth to be in the high single-digits in 2019. BATS’ 2017 acquisition of Reynolds American has lifted the group revenue by over 50% and added about 70% to operating profit during the first half of 2018.

The strong brand holdings of British American Tobacco contribute to the strong balance sheet. BATS brands include Dunhill, Lucky Strike, Rothmans, Kent and Camel. British American Tobacco is also putting strategic resources into ‘next-generation’ products, which it labels as “potentially reduced-risk” products that do not burn but rather heat tobacco. The addictive nature of smoking, coupled with brand loyalty shown by most smokers, gives BATS pricing and competitive power within this non-cyclical market.

Cons for British American Tobacco shares

The tobacco sector is currently under intense pressure. As western countries witness declining smoking rates, global regulators such as the US’s Food and Drug Administration are also voicing concerns about the next generation (or the so-called reduced risk) products, which are reported to be attracting underage consumers. BATS recently reported a flat heated tobacco market in Japan, and decreased its full-year revenue target by about 10% in this segment.

Furthermore, analysts are concerned about the high long-term debt levels of British American Tobacco, which have increased as a result of the purchase of Reynolds American for over £40 billion last year. In the current rising interest rate environment, BATS will need to reduce this debt through cost-cutting measures.

Finally, the short-term technical analysis points to further headwinds for the British American Tobacco share price. The company’s short-term chart still looks weak and it is pointing to the possibility for more downside around the corner. BATS’ 52-week price range has been 3,171-5,180p, and the share price is likely to test this low again in the coming weeks. The shares will need to stabilise and build a base again before a long-term sustained boost can occur.

The bottom line on British American Tobacco shares

Despite concerns about increased regulatory restrictions against tobacco and ‘next-generation’ products, BATS management is committed to growing revenues and the company’s fundamental story remains intact. If you also still believe in the bull case for BATS shares then you might, however, consider waiting for a better time to buy, such as a share price of mid to high 2,000p. Expect near-term trading to be choppy at best until the volatility in the broader market decreases, probably towards the end of the year.

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Tezcan Gecgil has no position in any of the shares mentioned. 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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