British American Tobacco (NYSE:BTI) (LSE:BATS) stock continues to trade at depressed levels. However, smart capital allocation practices recently, combined with shares currently attached to a tremendous 9.7% yield, should sustain its bullish case. Admittedly, Wall Street’s negative sentiment is not unfounded, as cigarette sales volumes continue to face pressures globally. Nevertheless, progress from non-combustibles and a clear path toward shareholder value creation form a promising case. Thus, I remain bullish on BTI stock.
Sales from Combustibles Keep Facing Intense Pressure
Let’s begin by addressing the most notable bearish factor in BTI’s investment case: the severe pressure on combustibles, whose sales volumes have been declining at an alarming rate lately. Sure, other factors are pushing shares lower, too, including elevated interest rates, regulatory risks, a general bearish sentiment affecting the U.K. equities market, and a broad dislike that many investors have toward tobacco stocks. Yet, the challenges related to combustibles seem like the most prominent catalyst.
In the company’s H1-2024 results prepared remarks, management addressed this issue, mentioning that industry volumes across combustibles were down around 9% year-to-date and around 11%, excluding the discounted brands market, where BTI is not present. We have seen such declines from some of BTI’s peers lately, such as Altria (NYSE:MO) and Philip Morris (NYSE:PM) in their respective cigarette-based divisions, confirming the rather dire market conditions in the product category.
Nevertheless, BTI was once again able to more than offset these product category-wide declines through pricing. Combustibles generated £10.65 billion for BTI during the first six months of its fiscal year, growing from last year’s £10.50 billion. Other wins in the space include strong results from the company’s Newport brand, which, along with share gains from its Natural American Spirit brand, drove its volume share of the Premium segment up 40 bps compared to last year.
Non-Combustibles Keep Making Progress
While BTI’s combustibles division finds ways to survive and even thrive during the challenging industry environment, its non-combustible products showed signs of improvement across the board.
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In Vapour, Vuse managed to maintain global leadership with a 41.1% value share despite a dip in the U.S. due to illicit vapes.
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In Heated Products, Glo’s volume share has started to stabilize, down only 20 basis points year-to-date compared to a 110-point drop in 2023.
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In Modern Oral, Velo excelled, boosting BTI’s total oral volume share by 80 basis points to 10.3%. BTI held 65% of the Modern Oral category in AME (Americas ex-U.S. & Europe), leveraging its position in established markets like Sweden and newer ones like the UK and Poland.
Therefore, the company was able to grow this division’s revenues to £2.16 billion, up from £2.10 billion last year.
Smart Capital Allocation, Hefty Yield Seal the Deal
Operations aside, BTI’s management seems to have made some smart capital allocation decisions in an effort to address current investor concerns and improve shareholder value. Along with the stock’s hefty yield, I am convinced that BTI’s investment case remains quite attractive.
In particular, in March, BTI successfully finalized the sale of a 3.5% stake in its ITC shareholding (ITC is India’s largest, publicly traded tobacco player), allowing the start of a sustainable share buyback, including plans for £700 million in 2024 and £900 million in 2025. BTI is also using its own free cash flow to deleverage. Management expects that the firm will reach its narrowed leverage target range of 2.0-2.5x adjusted net debt/adjusted EBITDA by year-end 2024.
In the meantime, shares continue to be attached to a hefty dividend yield of 9.7%. The dividend was hiked again this year, with its current annualized rate standing at £2.3552 (or about $2.79). It remains sufficiently covered by adjusted earnings-per-share (EPS), which are expected to land at £3.62 this year.
Such a hefty, well-covered dividend yield should provide a notable margin of safety against further share price losses in the near term. Further, BTI’s buybacks at current levels should prove to be quite accretive, given that the savings on future dividends are going to be massive for shares repurchased at current levels.
Is British American Tobacco Stock a Buy, According to Analysts?
Regarding Wall Street’s view on the stock, BTI stock has gathered a Moderate Buy consensus rating based on five Buys and three Hold ratings assigned in the past three months (in its U.K. listing, where the stock is better covered). At 2,966.67p (about $38.09 at current FX), the average British American Tobacco stock price target suggests 24.1% upside potential.
The Takeaway
While British American Tobacco is not immune to the challenges affecting the combustibles industry overall, its brands continue delivering solid results. Further, its Non-Combustibles division shows improvements across the board.
To top it off, management seems to be decisive in improving the balance sheet and rewarding patient shareholders who have stuck with BTI, showing a welcome mix of debt paydown and capital returns. Considering all factors, BTI’s bullish case seems quite promising, which is why I remain a shareholder in the stock.
