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British American Tobacco looks to expand into cannabis. Is BATS a good investment?

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In the wake of two new cannabis stocks listing on the London Stock Exchange this week (Kanabo and MGC Pharmaceuticals), 119-year-old British American Tobacco (LSE:BATS) is considering its options in the space.

British American Tobacco’s foray into CBD

The FTSE 100 stalwart has been struggling in recent years as tobacco falls out of favour. Nowadays, it still sells big brand cigarettes such as Lucky Strike and Rothmans, but it’s also been repositioning into smoking alternatives such as vaping. Given its growing popularity, cannabis seems like the next logical step.

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Speaking to CNBC, BATS Chief Marketing Officer Kingsley Wheaton said: “last year we signalled that we would look at consumer spaces beyond nicotine and indeed CBD would be one of those…it’s an exciting growth area for our business for the future”.

CBD or cannabidiol, is a cannabis ingredient derived from hemp. While consumer demand is rocketing, the regulatory landscape remains pretty strict. And this becomes particularly complex between countries and regions.

British American Tobacco has begun a CBD pilot program in Manchester. Its VUSE CBD Zone is a CBD vaping product. It currently comes in three flavours and two strengths.

Is British American Tobacco profitable?

BATS has a price-to-earnings ratio of 9, earnings per share are £2.10, and it’s one of the best dividend payers on the FTSE 100 at 8%. However, the dividend cover is only at 1 times, so it wouldn’t take much for a cut to be considered. Particularly as the company has £40bn of net debt.

Nevertheless, the pandemic hasn’t been as hard on BAT’s bottom line as we might have expected. It’s been growing its revenues, profits, and earnings despite the difficult backdrop. The company is now speeding up the transformation of its business. This includes becoming more tech-savvy. It’s made a significant shift into e-commerce and year-on-year its online revenues are up 200%, with subscribers now at 20,000.

The Covid-19 travel restrictions did thwart sales of its duty-free cigarettes, but a surge in demand for its vaping kits has made up for this.

In its full-year preliminary results posted on Wednesday, BATS reported close to a 9% rise in profits. Its VUSE and VYPE vaping kit sales climbed 52%. And its online vape sales rose 40% as 17,500 people signed up to become regular subscribers.

These are positive signs of a transition in progress, but British American Tobacco still faces many challenges. 

Person smoking cigarette

Diversifying its product pipeline

Staying relevant and financial fund friendly in an environmental, social, and corporate governance (ESG) environment is a hurdle tobacco firms are facing. Many investors in exchange-traded funds (ETF) now demand ESG-friendly portfolios devoid of tobacco and other sin stocks. British American Tobacco is clearly aware of this and is on a mission to reduce the harm of its business.

It has been cost cutting and re-evaluating to focus on building a portfolio and brands of the future. One possible entrant is its CBD products, but it also has other ideas for diversification in the pipeline.

The company is often considered a recession-proof stock because it sells products that people will buy no matter how the economy looks. But the British American Tobacco share price fell on news of the results, despite beating analysts’ expectations.

I think this looks a good dividend stock for a long-term portfolio, but I’m reluctant to own it because of the damage cigarettes do.

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Kirsteen 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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