Hello, fellow investors!
I have recently added British American Tobacco to my portfolio as I believe that its current share price presents an exceptionally compelling risk-reward proposition when weighed against alternative investment opportunities. Following is a concise summary of my reasoning that I would like to present for your feedback.
THE BEST OPPORTUNITIES ARE TO BE FOUND IN BEAR MARKETS
Sooner or later, regardless of how exceptional they are, companies find themselves in the midst of multi-year downturns. It happened to Coca Cola, PepsiCo, Microsoft, and Apple, just to name a few.
The only time British American Tobacco has been cheaper than today was at the end of the largest civil litigation settlement in U.S. history, which resulted in the tobacco companies paying the states and territories billions of dollars in yearly instalments. It went then on to become a 15-bagger over the subsequent 17 years, not accounting for dividends.
Now, the company does currently face noteworthy challenges (i.e. negative secular trends in smoking and a substantial debt burden), but the current valuation seems to be factoring in a higher level of risk than may actually exist.
DECLINING SMOKING RATES
Even though smoking rates continue to decline, the company is effectively offsetting the trend through a successful diversification of its product portfolio. The oligopolistic nature of tobacco markets also gives them significant pricing power, especially since demand for their products is relatively inelastic, resulting in inordinate profitability and robust cash flows.
DEBT BURDEN
The company has debt maturities of around £4 billion annually in the next two years, and due to higher interest rates, net finance costs are expected to increase as debts are refinanced.
However, it currently holds about £4 billion in cash, expects to generate at least an additional £5+ billion in post-dividend free cash flow, and had access to an undrawn £5.5 billion revolving credit facility as of 30 June 2023. This sums up to more than £14 billion in liquidity available to meet its debt obligations within the specified time frame. Contrary to claims of insolvency, the company's financials demonstrate otherwise.
HEADS I WIN, TAILS I…STILL WIN
It does not happen very often that companies with cash flows so consistent and predictable offer a FCF yield of 17%. Not to mention the fact that they're still growing earnings and that a multiple expansion is not unlikely over the next decade (In 2000, the company traded at just 7x earnings before eventually returning to its historical norm of 13 to 14x).
This is an immensely-wide moat and non-cyclical stock currently paying a 9% dividend yield with a conservative 60% earnings payout ratio and a well-established track record of dividend payments spanning many decades. Investors are getting average stock market returns from the dividend alone.
I wanted to keep the post short and focus on the company's primary key facts, but I hope nonetheless you found the information interesting and worthy of further exploration!
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