TOP CONTRIBUTORS

Alexander Witkes

Vikram Parsani

British American Tobacco (LSE: BATS, AMEX:BTI) is the second largest quoted global tobacco company by market share, and with operations in over 180 markets, it is the "most international" tobacco company in the world ^[1]. The Company's brand portfolio consists of over 300 brands, namely, Dunhill, Kent, Lucky Strike and Pall Mall, and includes ready-made cigarettes, cigar, roll-your-own, pipe, and smokeless tobacco products ^[2]. British American Tobacco was founded in 1902 through a joint venture between the Imperial Tobacco Group (IMT-LN) and the American Tobacco Company (USA) ^[3].

Despite the company's international presence, it does not currently directly sell cigarettes or other tobacco products in the United States. Instead, British American Tobacco indirectly sells Pall Mall and other brands through Reynolds American (RAI) in the United States, a company of which British American Tobacco has 42% ownership following a deal with R.J. Reynolds Tobacco Holdings, Inc. in July 2004. ^[4] However, British American Tobacco does have the largest market share in over fifty geographic markets and has the most significant sales in Europe, which made up about 40% of the company's revenue in 2008. ^[5]

In 2008, British American Tobacco acquired two companies, Tekel, a Turkish tobacco company, and Skandinavisk Tobakskompagni (ST), a Danish tobacco company, for $1.72 billion ^[6] and £1.15 billion^[7], respectively. These acquisitions strengthened British American Tobacco's position in its Africa and Middle East and Europe region, and contributed to net income growth from 2007 to 2008 of 44% and 15% in each region, respectively. ^[8]

As British American Tobacco sells tobacco products it is affected to a large degree by exogenous factors, notably tobacco litigation and smoking bans. The prevalence of public smoking bans in the United States only affects the company through its ownership of Reynolds American; however, many European countries, including France, Germany, Italy, Spain, and the United Kingdom, have enacted laws that prohibit smoking in various public places.^[9] Given that about 40% of sales are in Europe, this trend threatens the sale of tobacco products. Yet, in 2008, the company's diversification and emphasis on markets with growing numbers of smokers has led to net income growth of 44% in Europe, despite the smoking bans. British American Tobacco's international diversification also exposes the company to exchange rate fluctuations, and between 2007 and 2008, revenues increased by 11% at a constant rate of exchange, as compared to 21% when exchange rates are taken into account.^[10]

Company Overview

British American Tobacco is one of the five largest tobacco companies in the world. Although it manages and sells over 300 brands, the Company considers Dunhill, Kent, Lucky Strike, and Pall Mall to be its four Global Drive Brands ^[11].

Business and Financial Metrics

Total Revenue and Net Income for British American Tobacco (£M) ^[12]

British American Tobacco's Earnings Per Share (EPS) has had a 13.2% compounded annual growth rate (CAGR) from 2003 to 2008, and in 2008 it had an adjusted EPS of 128.8p (up from 108.5p in 2007) ^[13]. Despite the difficulties facing other companies due to the global financial crisis, in 2008, BATS increased its revenue by 21% to £12,122 million from £10,018 in 2007 and increased net income by 16% to £2,659 million from £2,287 in 2007 ^[14]. A sales volume increase of 4.5% over the same period^[15], and Global Drive Brand sales growth of 16%, ^[16] which were less than the increase in net income, are a testament to the company's market leadership and ability to set premium prices.

Moreover, British American Tobacco's strong free cash flow (FCF) gives the company flexibility to retire its £1.1 billion of debt related to its acquisitions of Tekel and ST during 2009 if it so chooses. ^[17] The company earned 52% growth in FCF in 2008, to £2,604 million from £1,711 million in 2007; yet, it still decided to suspend its share buyback program. However, similar actions were taken by Altria and Reynolds America, of which British American Tobacco owns 42%.^[18] British American Tobacco's vertically integrated supply chain and its Social Responsibility in Tobacco Production program ^[19], the company is able to control costs, and as such, raw materials and consumables used expenses remained at a constant percentage of revenue, 28%, from 2007 to 2008.^[20] Through the program, the company buys 66% of its tobacco leaf from growers who receive direct agronomy support from British American Tobacco, and these services cover 19 countries, 250,000 growers, and 200,000 hectares^[21] As a result, the company maintains a 30.7% operating margin^[20].

British American Tobacco has increased its dividend by at least 8% every year since going public in 1998, and in 2008, it paid out dividends of 83.7p/share ^[22].

Geographic Regions

FY2008 BATS sales volume by geographic region ^[27]

FY 2008 BATS sales revenue by geographic region ^[28]

Europe (39.14% of Revenue, 13.10% of Net Income^[29])

In Europe, where about 40% of sales occur, British American Tobacco earned £1,213 in net income in 2008 due to the acquisition of ST and growth in Russia, eastern Europe, Spain, and other countries, a 44.06% growth in net income from 2007.^[30] Although the ST acquisition accounted for 24.8% of European net income growth in 2008, net income increased throughout the region due to volume growth, higher prices, and better margins, particularly in Russia, Spain, and Romania.^[30] Between eastern and western Europe, volume was distributed at 137.3 and 122.6 million and net income was distributed at £468 and £760 million, respectively.^[31]

Asia-Pacific (17.74% of Revenue, 21.41% of Net Income^[29])

The Asia-Pacific region had volume growth of 5%, to 152.5 million and revenue growth of 15%, to £2,151 million^[31], which accounted for net income growth of £132 million to £804 million.^[32] British American Tobacco performed well in Pakistan, in particular, as its market share in the country increased from 45% to 46.4%^[33] Vietnam, South Korea, and Australia also had increased net income, as a result of improved operating margins and higher prices.^[32]

Latin America (18.53% of Revenue, 25.81% of Net Income^[29])

Net income growth of £78 million, which resulted in overall net income for the region of £759 million, was driven largely by sales in Brazil; however, favorable exchange rate movements also had an impact on British American Tobacco's performance in Latin America. Market share in Brazil increased to 62.2% from 60.9% during 2008.^[33] Despite a volume decline of 2.2% in 2008, the company still had revenue growth of 13%, due to pricing power.^[31]

Africa and Middle East (14.82% of Revenue, 26.76% of Net Income^[29])

The Africa and the Middle East region was the site of British American Tobacco's fastest sales growth, as volume increased by 19.4%, revenue increased by 24%, and net income increased by 14.8% to £536 million.^[31] Although volumes grew in Nigeria, Egypt, and Saudi Arabia, the acquisition of the Tekel, a Turkish tobacco company, was the main catalyst of growth in the region.^[34]

American-Pacific (9.76% of Revenue, 12.91% of Net Income^[29])

Although the American-Pacific region was the smallest in terms of net income in 2008 with £515 million^[31], it was also the region with the greatest operating margin^[35] An operating margin of 43.5%^[35] and profit per mille of £12.61^[36] led to a £69 million increase in net income, despite a volume decline of 3.6%.^[31] Within the region, higher pricing and favorable exchange rates in Canada and Japan helped contribute to the American-Pacific net income.^[37]

Key Trends and Forces

Ongoing tobacco litigation and smoking bans in countries throughout the world threaten British American Tobacco

Although there are 30 states, in addition to Puerto Rico and Washington D.C., which have state laws that require smoke-free workplaces, restaurants, or bars, British American Tobacco currently has no direct sales in the United States, so the Company is not directly affected by American smoking laws ^[38]. However, British American Tobacco has a 42% ownership stake in Reynolds American^[4], and many countries throughout the world in which BATS does conduct operations have enacted laws that limit smoking in public places. In Europe, France, Germany, Italy, the United Kingdom, and others have all passed laws which ban smoking in bars, restaurants, and other public places ^[39].

Related to smoking bans is the general rate of tobacco consumption in countries throughout the world, which is influenced to a large extent by factors exogenous to BATS' marketing. Anti-smoking groups, government officials, health agencies and other non-governmental organizations all attempt to discourage smoking by advertising the health risks of cigarettes and other tobacco products. These groups have been successful in the United States, as smoking rates among adults have decreased by more than 50% since the 1960s; however, British American Tobacco does not currently sell products in the U.S. market. Moreover, smoking rates in the developing world, which is the source of more than 50% of BATS' revenue, have been increasing by 3.4% per year ^[40].

While these factors clearly have implications for global tobacco demand, British American Tobacco was nonetheless able to increase its revenue by 21% in 2008, which suggests that the Company is able to overcome, too a large extent, the legal and political difficulties associated with the tobacco industry ^[41].

Exchange rate movements have a significant impact on British American Tobacco

Given the international nature of British American Tobacco and its presence in over 180 markets, the company is forced to conduct its operations in many different currencies. In 2008, exchange differences resulted in a £16 million net gain, as compared to a £12 million net gain in 2007 ^[42]. While revenue increased by 21% between 2007 and 2008, at a constant rate of exchange, revenues increased by only 11% over the same period ^[43]

British American Tobacco benefited from these movements over the past two fiscal years; however, exchange rate movements are exogenous to the Company's performance. Moreover, the Company's operations in emerging economies makes it is susceptible to sudden stops that lead to rapid devaluation of a country's currency and reduces demand.

Global Recession Erodes Pricing Power and Premium Brand Growth

Although cigarettes and other tobacco products are recession resistant goods, within the cigarette market, the 2009 recession has caused consumers to substitute premium cigarette brands for low-cost competitors of British American Tobacco. In particular, Kent and Lucky Strike, two of the company's four Global Drive Brands, had slowed growth rates of 3% and 4% in 1Q09, respectively. In 2008, Kent and Lucky Strike grew at rates of 18% and 9%, respectively. ^[45] Not only have smokers substituted cheaper cigarettes for British American Tobacco products, but in eastern Europe, cigarette smuggling has further reduced sales. ^[46] Nonetheless, British American Tobacco had an overall volume growth of 7% for 1Q09, which suggests that the company is still well positioned to continue its earnings growth.^[45]

Competition

British American Tobacco has five major competitors in the tobacco industry, they are:

• China National Tobacco Company: The largest cigarette company in the world, China National Tobacco Company is owned and managed by the Chinese government, and sells 1.5 trillion cigarettes annually, all in China.^[47]
• Philip Morris International (PM): PMI is a spin-off from Altria Group as of March 28, 2008, and in 2008 sold tobacco products in over 160 countries.^[48] Philip Morris is best known for its Marlboro brand, and with volumes of over 310.7 billion in 2008--more than British American Tobacco's four Global Drive Brands combined--it is the best selling cigarette brand in the world^[49]. The company had revenue of $63,640 million and net income of $6,890 million in 2008.^[48]
• Japan Tobacco International (JAPAF): This company owns and manages three of the top five intentional cigarette brands, Winston, Camel, and Mild Seven, as well as other cigarette brands and tobacco products.^[50] During the fiscal year ended March 31, 2009, the company had net sales of ¥6,832,307 and net income of ¥123,400, a 48.3% decrease from 2007.^[51]
• Altria Group (MO): Altria sells brands such as Marlboro, Copenhagen, Skoal and Black & Mild, through its four operating companies, Philip Morris USA, U.S. Smokeless Tobacco Company, and John Middleton. In addition to cigarettes and tobacco products, Altria sells premium wines through Ste. Michelle Wine Estates and has a 25.8% ownership stake in SABMiller.^[52] In 2008, Altria Group had revenue of $19.5 billion and net income of $4.9 billion.^[53]
• Imperial Tobacco Group (IMT-LN): The company has sales in over 160 countries and a portfolio of brands, led by Davidoff.^[54] In 2008, Imperial Tobacco Group had volumes of 292 billion, revenue of £5,238 million, and net income of £1,157 million.^[55]

References

1. ↑ British American Tobacco
2. ↑ British American Tobacco, "Our Brands"
3. ↑ British American Tobacco, "Our History"
4. ↑ ^{4.0 4.1} Reynolds American Inc.
5. ↑ British American Tobacco. Who We Are.
6. ↑ Bloomberg, BAT Bids $1.72 Billion to Win Turkey's Tekel Auction
7. ↑ Times Online, British American Tobacco to buy Denmark's Skandinavisk Tobakskompagni for £1.15bn
8. ↑ British American Tobacco. Our Regions.
9. ↑ BBC News. Smoking Curbs: The Global Pictures
10. ↑ BATS 2008 Preliminary Results, page 4
11. ↑ 2008 BATS Preliminary Results to 31 December 2008, page 4
12. ↑ 5 Year Summary
13. ↑ BATS Preliminary Results Presentation, page 4
14. ↑ BATS 2008 Preliminary Results, page 11
15. ↑ BATS 2008 Preliminary Results, pg. 17
16. ↑ BATS 2008 Preliminary Results, pg. 1
17. ↑ BATS Preliminary Results Presentation, page 34
18. ↑ BATS Preliminary Results Presentation, page 32
19. ↑ British American Tobacco. Social Responsibility in Tobacco Production
20. ↑ ^{20.0 20.1} QU/$FILE/medMD7PSDYL.pdf?openelement BATS Preliminary Results Presentation, pg. 11
21. ↑ British American Tobacco. Responsible Leaf Production.
22. ↑ Dividend History
23. ↑ BATS 2008 Preliminary Results, page 11
24. ↑ 5 Year Summary
25. ↑ Volumes since 1999
26. ↑ Net Operating Margins since 1999
27. ↑ 2008 BATS Preliminary Results to 31 December 2008
28. ↑ 2008 BATS Preliminary Results to 31 December 2008
29. ↑ ^{29.0 29.1 29.2 29.3 29.4} BATS 2008 Preliminary Results, page 21
30. ↑ ^{30.0 30.1} BATS 2008 Preliminary Results, pg. 4-5
31. ↑ ^{31.0 31.1 31.2 31.3 31.4 31.5} BATS 2008 Preliminary Results, pg. 21
32. ↑ ^{32.0 32.1} BATS 2008 Preliminary Results, pg. 6
33. ↑ ^{33.0 33.1} BATS Preliminary Results Presentation, pg. 51
34. ↑ BATS Preliminary Results Presentation, pg. 7-8
35. ↑ ^{35.0 35.1} BATS Preliminary Results Presentation, pg. 48
36. ↑ BATS Preliminary Results Presentation, pg. 47
37. ↑ BATS 2008 Preliminary Results, pg. 8
38. ↑ American Nonsmokers' Rights Foundation. How Many Smokefree Laws?
39. ↑ BBC News. Smoking Curbs: The Global Pictures
40. ↑ World Health Organization. Smoking Statistics
41. ↑ BATS 2008 Preliminary Results Presentation
42. ↑ BATS 2008 Preliminary Results, page 27
43. ↑ BATS 2008 Preliminary Results, page 4
44. ↑ BATS 2008 Preliminary Results, page 22
45. ↑ ^{45.0 45.1} BATS 1Q09 Interim Management Statement, pg. 1
46. ↑ Bloomberg. BAT Premium Shipment Growth Slows in First Quarter
47. ↑ Yahoo! Finance. Tobacco Industry Profile
48. ↑ ^{48.0 48.1} New York Times Topics. Philip Morris International
49. ↑ Philip Morris International. Our Brands
50. ↑ Japan Tobacco International. Our Brands.
51. ↑ Japan Tobacco. Consolidated Financial Results for Year Ended March 31, 2009
52. ↑ Altria. Our Companies and their Brands
53. ↑ New York Times. Financial Tables: Altria Group, Inc.
54. ↑ Imperial Tobacco. Group at a Glance.
55. ↑ Imperial Tobacco 2008 Financial Highlights
56. ↑ Morgan Stanley Consumer Retail Conference Presentation, pg. 6