British American Tobacco delivers on its plans

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British American Tobacco delivers on its plans
Credit: © Reuters.

I don't think you will find a company on the market that tries harder to convince you that ESG is at the heart of what they do than British American Tobacco (JO: SNHJ ) (BAT (LON: BATS )). Cigarettes have been killing people for years, so some investors won't touch BAT on principle.

If it keeps you warm and fuzzy at night knowing you invest in ESG passive index tracking products, then you'll be thrilled to know that BAT is a top-three ESG company in the FTSE-100 index and has been in the Dow Jones Sustainability Indices for the 20th consecutive year.

I pass no judgement here. I merely ask you to be sceptical whenever the "ESG" label is put on a product. Frankly, I would have more faith in the labels on the cigarette boxes themselves.

Those who invest in BAT are looking for defensive exposure that pays dividends under almost any global circumstances. You may not smoke and your friends may not smoke, but plenty of people across the world still do.BAT is on a mission to grow its New Categories business, as global volumes in the tobacco industry are shrinking (expected decline of 2.5% in 2022). Despite this, BAT expects to grow revenue by 3% to 5%, which should generate high single-digit earnings per share (EPS) growth on a constant currency basis.

The business looks set to continue making a fortune over the next few years. Operating cash flow conversion is expected to be over 90% in 2022 and free cash flows are expected to be around GBP40 billion over the next five years. A share repurchase plan of GBP2 billion has been approved for 2022.

In 2021, New Categories growth contributed nearly half of group growth. Non-combustible products accounted for 12% of group revenue in 2021, up from 4% in 2017. BAT owns the leading vapour brand by value share globally (Vuse) which grew revenues 59%. Other New Categories businesses include the THP product, glo (up 46%), and the oral product, Velo (up 41%).

The group aims to deliver GBP5 billion of revenue from New Categories by 2025, by which time this division should be profitable. It hopes that customer numbers for non-combustible products will increase from 18.3 million to 50 million consumers by 2030.

The investment in New Categories is funded by growth in revenue in the segment as well as savings in group expenses, which the group hopes will reach GBP1.5 billion in total annualised savings by 2022. Investment in this side of the business was GBP496 million in 2021.

In 2021, revenue increased 6.9% on an adjusted basis (i.e. without taking into account currency movements) and decreased 0.4% without adjustments. On an adjusted basis, operating profits increased 5.2% and operating margin decreased by 70 basis points to 43.4%.

The group generated GBP10 billion in net cash from operating activities, an operating cash flow conversion rate of over 95%. This helped the group achieve its goal of reducing debt to 3x net debt / adjusted EBITDA.

Much of the investment case for BAT is based on its strong dividend yield and the dividend policy that sees dividends declared and then paid over four quarterly instalments. The board has declared a dividend of 217.8 pence per share, which will be paid in equal quarterly instalments in May, August, November and finally February next year. This represents a payout ratio of 66.2% on adjusted diluted earnings per share.

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