Shares in FTSE 100 giant British American Tobacco (LSE: BATS) were on smoking form this morning as market participants lapped up the latest set of interim results from the £68bn cap business.
In spite of this healthy rise, I still think the stock offers considerable value. Before explaining why, let’s take a look at the most important numbers from today’s statement.
Back on track
Revenue increased 4.1% to £12.1bn at constant currency rates over the first six months of 2019, with growth elsewhere more than offsetting the 3.5% decline in cigarette volumes seen over the period.
It’s particularly worth highlighting the 27% rise in sales of the company’s ‘New Categories’ products (to £531m) since it’s this part of the business that will play an increasingly important role in British American’s ability to continue raking in cash going forward.
Broken down, sales of Tobacco Heating, Vapour and Modern Oral products rose 4% (£301m), 58% (£183m) and 284% (£47m) respectively. With further launches planned in H2, British American believes it’s now back on track to hit the middle of its targeted 30%-50% growth range in this area.
Despite increased investment in these new products, adjusted operating profit was also up 5.9% at constant currency to £5.21bn. Encouragingly, this number was a slight beat on the £5.14bn expected by analysts.
Considering the above, it’s perhaps no surprise that the shares were up over 6% this morning. That’s not to say, however, that prospective investors should worry about missing the boat. Even after taking today’s gain into account, the stock is still around 40% lower in price than it was a couple of years ago.
I think the market is too pessimistic on British American. A price-to-earnings (P/E) ratio of just 9 at yesterday’s close is far below its five-year average valuation of 16.5. Having said that, it’s now targeting “high-single-figure adjusted earnings growth” for the full year, I’m wondering if today’s rise may be the beginning of a sustained (albeit very gradual) recovery.
Let’s not forget British American’s income credentials either. A proposed 203p per share total dividend in 2019 gives a yield of 6.5%. That’s clearly way higher than the 4% median across the index, but not so high that a cut looks likely, at least for now. Since it remains confident of generating more than £1.5bn in free cash flow in 2019 even after the payment of dividends, I think those invested purely for the quarterly cash payouts can sleep soundly.
While the decline of traditional smoking continues in the West, it’s also worth remembering that approximately 1.1 billion people in the world still engage in the habit and that numbers are actually increasing in some countries due to population growth. This surely makes companies like British American far more defensive than your typical technology play whose clients will quickly move on to different products or services at the drop of a hat.
Of course, there are still challenges ahead.
For one, the rising popularity of next-generation products won’t be going unnoticed by the US Food and Drug Administration. In addition to the likelihood of further regulation, the FTSE 100 member must contend with competition from rivals such as Philip Morris whose recent shipment volumes have been better than those reported today.
Nevertheless, based on these half-year numbers and its lowly valuation, I continue to be bullish on British American’s future.
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Paul Summers 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.