British American Tobacco p.l.c.

British American Tobacco p.l.c. Annual Report: A Comprehensive Review

Delving into British American Tobacco's (BAT) latest 20-F filing, this summary offers investors a clear and concise overview of the company's performance and strategic direction. We'll explore key financial results, strategic initiatives, and the risks most relevant to shareholders.

1. Business Overview and Performance Highlights British American Tobacco (BAT) operates globally in tobacco and nicotine products. Its business divides into traditional combustible products (cigarettes) and a growing portfolio of "New Categories": Vapour (e-cigarettes), Heated Tobacco Products (HTP), and Modern Oral products. This year, BAT continued its strategic pivot towards these reduced-risk alternatives, aligning with its "A Better Tomorrow" vision.

Financially, BAT reported £27.65 billion in revenue for the fiscal year, a 3.1% increase when excluding currency fluctuations (at constant currency). This growth was primarily driven by strong New Category performance. However, reported revenue saw a slight 0.5% decline due to unfavorable foreign exchange movements. Operating profit reached £12.45 billion, up 1.6%, reflecting effective cost management despite inflationary pressures.

2. Financial Performance: Revenue, Profit, and Growth Metrics BAT's financial performance navigated a dual trend: a continued decline in combustible volumes largely offset by robust growth in New Categories.

• Combustibles: Volume declined by 5.4%, impacting revenue in mature markets. However, strategic pricing helped mitigate this revenue impact.
• New Categories: This segment served as the primary growth engine, with revenue surging by 20.8% to £3.35 billion. Vapour products attracted 15% more consumers, HTP grew by 18%, and Modern Oral products expanded their user base by 25%. This growth highlights the success of BAT's investment in next-generation products.
• Regional Performance: The Americas & Europe region demonstrated resilience, as New Category growth partially offset combustible declines. Asia Pacific, Middle East & Africa (APMEA) delivered strong growth, particularly in HTP. In contrast, the U.S. market faced specific challenges from macroeconomic factors and regulatory uncertainty in the Vapour segment, though it remained a significant contributor to overall profit.

3. Major Wins and Challenges This Year Wins:

• Accelerated New Category Growth: BAT surpassed its targets for New Category revenue and profitability, showcasing a successful portfolio transformation.
• Strong Cash Generation: The company generated robust operating cash flow of £10.5 billion, enabling both debt reduction and shareholder returns.
• Dividend Payout: BAT maintained a strong dividend policy, reflecting confidence in its future cash flows. Challenges:
• Combustible Volume Decline: Traditional cigarette volumes continued to face pressure across most markets.
• Regulatory Headwinds: New Categories, particularly Vapour products, faced increased scrutiny and potential restrictions in key markets like the U.S.
• Inflationary Pressures: Higher input costs and energy prices impacted margins, though pricing and efficiency programs partially offset these effects.
• Foreign Exchange Volatility: Unfavorable currency movements negatively affected reported revenue and profit.

4. Financial Health: Cash, Debt, and Liquidity BAT maintains a strong financial position. Net debt decreased by £2.5 billion to £37.5 billion, bringing its net debt to adjusted EBITDA ratio to 2.9x – well within its target range. Robust liquidity, supported by diverse debt instruments (including bonds and credit facilities) and strong cash generation, underpins the company's financial stability. BAT successfully refinanced maturing debt, demonstrating continued access to capital markets. Shareholder equity reached £55.2 billion.

5. Key Risks That Could Hurt the Stock Price

• Regulatory Risk: Stricter regulations on both combustible and New Category products (e.g., flavor bans, marketing restrictions, excise taxes) could significantly impact sales and profits.
• Litigation Risk: Ongoing and potential future legal challenges, particularly in the U.S. and Canada regarding tobacco-related health claims and Master Settlement Agreements, pose a material financial risk.
• Competition: Intense competition in the rapidly evolving New Category space from both established players and new entrants could impact market share and pricing power.
• Consumer Preferences: A faster-than-anticipated shift away from nicotine products or towards alternative, non-BAT products could erode market share.
• Supply Chain Disruptions: Geopolitical events or global health crises could disrupt manufacturing and distribution.

6. Competitive Positioning BAT remains a global leader in the tobacco industry, with strong market positions in both combustibles and New Categories. The company leads the Vapour market in several key regions and rapidly expands its HTP and Modern Oral footprint. Its extensive global distribution network and strong brand portfolio (e.g., Dunhill, Lucky Strike, Vuse, Glo) offer a significant competitive advantage, though BAT faces strong competition from peers like Philip Morris International and Altria, especially in the New Category segment.

7. Leadership and Strategy Changes BAT reaffirmed its "A Better Tomorrow" strategy, focused on accelerating business transformation by growing New Categories to achieve £5 billion in revenue by 2025 and profitability by 2024. Key strategic pillars include:

• Portfolio Transformation: Prioritizing investment in Vapour, HTP, and Modern Oral products.
• Sustainable Growth: Driving efficiencies and cost savings across the business.
• ESG Focus: Enhancing sustainability efforts, including reducing the health impact of its business and achieving carbon neutrality. No significant changes occurred in executive leadership during the reporting period, ensuring continuity in strategic execution.

8. Future Outlook BAT anticipates continued growth in New Categories, projecting mid-single-digit revenue growth for the next fiscal year (excluding currency fluctuations). The company expects New Categories to become profitable by 2024, contributing positively to group earnings. BAT plans continued investment in innovation and market expansion for its reduced-risk products, while managing the decline in combustibles. It also reiterated its commitment to a dividend payout ratio of 65% of adjusted diluted earnings per share.

9. Market Trends and Regulatory Changes Affecting Them Global market trends show a continued decline in combustible tobacco consumption, especially in developed markets, driven by health awareness and public health campaigns. Conversely, the market for reduced-risk nicotine products is expanding rapidly, fueled by consumer demand for alternatives. Regulatory environments are becoming increasingly complex, with varying approaches to New Categories across different jurisdictions. The potential for flavor bans, marketing restrictions, and increased taxation on Vapour and HTP products remains a significant factor influencing future growth and profitability. BAT actively engages with regulators to advocate for proportionate and evidence-based policies.

Overall, BAT presents a complex investment case, balancing the decline of its traditional business with the promising, yet regulatory-sensitive, growth of its New Categories. Investors should weigh the strong cash flow and dividend against regulatory risks and the pace of transformation.