British American Tobacco plc
Financial Analysis Report
1. Introduction
The purpose of this report is to provide information & Interpretation of British American Tobacco plc (BAT) in terms of historical record, comparative financial indicators, and position in the market along with key value drivers for the company and performance indicators. This is done by analysing the information provided in the historical and present financial statements.
2. About British American Tobacco & Revenue Analysis
British American Tobacco (BAT) is a public company listed on the London Stock Exchange, which has direct and indirect stakes in several companies together constituting to be the British American Tobacco Group of companies. The group achieved gross turnover of GBP 40,713 million with revenues amounting to GBP 14,208 Million in the year 2009 (BAT plc Annual Report 2009, Pg.2). There are more than 250 brands in their portfolio with Dunhill, Kent, Lucky Strike & Paul Mall being their flagship cigarette brands which are together sold in more than 120 countries with total sales constituting 196 Billion cigarette units (BAT plc Annual Report 2009, Pg.4). The company follows the accounting cycle starting 1st January of the calendar year & ending on 31st December of the same calendar year. The group currently has 95,710 employees on its payrolls. It sold 724 Billion cigarette units in the FY 2009 and has production capabilities in 50 cigarette factories based in 41 countries (BAT plc Annual Report 2009, Pg.7).
(Figure 1)
(Source: Database, "FAME")
British American Tobacco is the second largest tobacco company in the world (Excluding China), while it has 6.4% share of the UK market, dominant players being Imperial Tobacco & Japan Tobacco International (Nielsen Data, Feb 2010). 74% of BAT's sales come from the developing countries & emerging economies (Database," FAME") (Figure 2)
(Source: BAT plc annual report 2009, Flap 1)
Revenue by Geography
BAT's largest market lies in Western Europe which accounted for 27.3% of its total revenues in FY 2009. BAT saw an increase of 20.7% from the revenues it had registered in the FY 2008. (Database, FAME)
(Figure 3)
(Source: Database, FAME)
Asia Pacific accounted for 23% of its total revenues while Americas accounted for 22.2%. Eastern Europe accounted for 11.5% of the total revenues while the highest performer for BAT turns out to be Africa and Middle East which accounted for 22.2% of the total revenues as it saw an increase of 31.2% in terms of year on year revenue over the previous financial year. (BAT plc Annual Report 2009, Pg.4)
(Figure 4)
(Source: BAT plc Annual Report 2009, Pg.4)
3. Historical Performance & Analysis
British American Tobacco was established as a joint venture between the Imperial tobacco group of the United Kingdom & the American Tobacco Group of the United States in the year 1902. Subsequently, In the year 1911 the company was listed on the London Stock Exchange. In 1913, the company looked overseas for expansion and entered the Argentinean markets. In the 1920s, British American Tobacco's capitalization had quadrupled since 1902 and sales grew nearly by a factor of 40. In 1923, The Company's worldwide sales had grown to 50 billion cigarettes per year. By 1962, British American Tobacco's capitalization allowed it to move towards diversification. It grew consistently, however, and was achieving turnover growth at the rate of 15% per annum by 1970. In 1986, only half of its total pre tax profit came from tobacco group which was down from 57% pre tax profit BAT achieved in the year 1985. The company continued with its strategy to take over small to midsized companies as it acquired Canada's dominant tobacco company, Imasco in the year 2000. The company has been consistently achieving Year on Year growth in the range of 8-12% in terms of revenue since 2005 till date (BAT plc Annual Report, 2005-2009). (Figure 5)
(Source: BAT plc Annual Report 2009, Pg. Flap 1)
4. Brief Annual Report Analysis
"The goal of accounting information is to provide economic decision makers with useful information," according to Williams, Haka, Bettne & Carcello (2006, p. 670). Financial statements analysis is not just important for the shareholders but various stakeholders as well.
The Group has prepared its annual consolidated financial statements in accordance with International Financial Reporting Standards (IFRS), as endorsed by the European Union. Some of the highlights of the Annual Report include revenue increase of 10% at constant rates of exchange & 17% at current rate, when compared to the financials for the year 2008. Adjusted profits from operations too increased by 10% at constant rates and 20% at current rates (BAT plc Annual Report 2009, Pg.7) The total benefit of the result amounted to GBP 355 Million, which resulted in adjusted diluted earnings per share grow by 19% to 153 pence (BAT plc Annual Report 2009, Pg.13). Over the past 5 years, BAT has achieved a compounded annual growth rate of 15% in earnings per share and 19 % in dividends per share. The total shareholder returns over the same 5 year has been 175% compared to the FTSE 100 index which gave 35% returns to the investors (Source: Database, Datamonitor, Company Analysis, British American Tobacco, 26th July 2010) (Figure 6)
(Source: BAT plc, Annual Report 2009, Pg. 2)
The group is viewed as a strong player in the global tobacco industry. The resilience in achieving profits & wealth generation along with geographical diversification has positioned the group as a multi national company with strong fundamentals, which makes it more susceptible to face risks and unforeseen events in the future. In the first half of the financial year 2009, Sales volumes had increased by 4% or declined by 2% when the benefit derived from acquisition was excluded (BAT plc Annual Report 2009, Pg. 113 - 116). BAT's free cash flow remained strong and resilient during the year 2009 and looks set to remain the same in the year 2010 despite volume pressures. Price increases & sales improvements continue to offset the volume pressure faced by the company in the broad range of other markets. BAT is likely to generate free cash flows despite various expenses like restructuring & dividend payments to the shareholders as it has ample internal liquidity, cash flow & access to capital markets.
5. Ratio Analysis
"A ratio is a simple mathematical expression of the relationship of one item to another," according to Williams, Haka, Bettner, and Carcello (2005, p. 674). Ratios can provide diverse information to diverse financial information users.
The analysis of annual report suggests the following ratio analysis of the group. The relevant ratios have been grouped and presented in this paper under various heads.
Profitability Assessment:
Operating Margin: BAT achieved an operating margin of 31.12% in the year 2009 mainly due to savings it achieved in supply chain, general overheads and indirect costs. The impact of higher leaf prices and input costs were offset due to these savings. It allowed the overall operating margin to increase from 30.7% to 31.4% in the year which was much greater than the industry and sector average of 22.01% and 10.10% respectively (Reuters Financial Highlights, reuters.com, BAT 2009 Financial Ratios). BAT also, had much better margins when compared to Japan tobacco & Imperial tobacco which could achieve operating margin of 4.76% & 12.13% respectively (Japan Tobacco International plc Annual Report 2009, Imperial Tobacco Group plc Annual Report 2009)
Return on Equity: BAT has been a fundamentally sound company demonstrating consistency in giving return on equity to its shareholders. In the FY 2009, BAT's Return on Equity was standing at 37.05% which was considerably higher than the industry and sector average of 11.57% and 8.01% respectively (Reuters Financial Highlights, BAT 2009 Financial Ratios). While Japan Tobacco & Imperial Tobacco could manage to achieve little less than 10% & 7.89% Return on Equity (Japan Tobacco International plc Annual Report 2009, Imperial Tobacco Group plc Annual Report 2009), BAT has been since the past able to maintain consistent returns. In the past four years starting 2005 - 2008, BAT gave returns of 26.12%, 27.70%, 28.95% & 30.44% respectively (BAT plc Annual Report 2005-2009). These numbers give confidence to investors and allowed BAT to be looked upon as a good company to place one's bet on.
Return on Capital Employed (ROCE): Corporate Profitability can be determined by assessing the trading profit that the company has achieved over the capital employed by it. BAT achieved an ROCE of 20.82% in the FY 2009 which is slightly better than the Industry average and sector average (BAT plc Annual Report, Pg 114-117). BAT fared approximately twice as better when compared to Japan Tobacco and almost four times better than Imperial Tobacco which achieved 4.61% (Japan Tobacco International plc Annual Report 2009, Imperial Tobacco Group plc Annual Report 2009).
Asset Utilisation:
Asset Turnover: BAT was able to main asset utilisation which was on par with the industry average. The industry average for the FY 2009 was 0.58 (Reuters Financial Highlights, reuters.com, BAT 2009 Financial Ratios), while BAT registered an asset utilization ratio of 0.73. The company is expected to register even better numbers in the near future as FY 2009 saw some acquisitions which resulted in BAT's performance on par with the market in terms of making its asset sweat. Closure of the Soeborg factory in Denmark, Downsizing of manufacturing plant in Australia and impairment charges for certain software assets resulted in these assets having minimum and limited future economic benefit. But with consolidation resulting in greater savings and better utilization of the assets of the companies acquired in the emerging markets, the asset turnover ratio is expected to fare better in the next financial year.
Risk Tolerance:
BAT's policy seems to be moderate as it focuses on maintaining EBITDA coverage of gross interest payments between 5x and 9x & at the same time maintaining cash balance exceeding USD 1 billion and five year maturity on its debt profile. BAT needs to strike a fine balance between acquisitions and share buy backs to avoid over stretching its debt capacity over a short time frame due its commitments to a 65% annual dividend payout ratio. In the year 2008, BAT reduced its annual buy back commitment from GBP 500 Million to GBP 270 Million to accommodate acquisitions (BAT plc Annual Report, Pg 155-159). BAT also suspended its buy back program in 2009 until further notice (BAT plc Annual Report, Pg 99).
Cash Flow Adequacy
Growing profitability would benefit the companies' debt protection metrics to a greater extent. Strong conversion of profits into cash supports BAT's financial metrics. The groups' future working capital requirements will remain stable in proportion to its annual sales unless there are any significant large scale acquisitions. BAT's capital expenditure of its net operating cash flows is very low when compared with the averages in food, beverage & tobacco industries. In the year 2009, BAT's capital expenditure accounted for 15%-20% of net operating cash flows (BAT plc Annual Report 2009, Pg 109). BAT's future capital expenditure is most likely to grow giving the compounded annual growth rate of the company along with the industry.
6. Key Performance Indicators
The key performance indicators for BAT have been its consistent ability to maintain growth in its core competency. Revenue for the FY 2009 grew by 17% which is 3 - 4 per annum greater than the target growing revenue for the medium and long term (Burrows, Richard, BAT plc Annual Report 2009, From the Chairman). This was possible due to acquisitions it made and favourable exchange rate movements.
One of the key strengths of the company in terms of its performance is its diversified global drive brands which constitute majority of the sales for the company. Though growth of 16% was achieved in the FY 2008 in this segment, FY 2009 volumes grew by 4% which is coherent with the company's strategy to achieve single digit growth over the long run.
(Figure 7)
(Source: Passport GMID)
The adjust profit from operations achieved by the firm was well above the company target to achieve 6% profit from operations. BAT registered a growth of 20% (BAT plc Annual Report 2009, Pg. 12).
The net cash from operating activities in the FY 2009 was up by GBP 26 million to GBP 2630 million. Free cash flow per share increased by 2%, the ratio of free cash flow to adjusted diluted earnings was 86%. (BAT plc Annual Report 2009, Pg. 9)
Adjusted Earnings Per Share (EPS) had grown at an average of 11% over the last ten years. This exceeds the company's target of growing at a single digit figure per annum on an average. Adjusted diluted EPS grew by 19% in the year 2009. (BAT plc Annual Report 2009, Pg. 9).
7. S.W.O.T. Analysis
Strengths:
Diversified Global Brand Drive (GBD) portfolio
Emerging Economies
Enhanced Internal Operations
Weaknesses:
Legal Issues
Poor Asset Utilization
Opportunities
Acquisitions
Growth of Tobacco Industry
Threats
Illicit Trade
Advertising restrictions
Consumer focus and awareness on health issues
What makes British American Tobacco work?
The year 2009 was a challenging year for the Fast Moving Consumer Goods (FMCG) segment. Total market volumes declined by 2% for the BAT products. The overall performance for BAT was firm. It continued to invest in its marketing initiatives which resulted in it maintaining its market share in key markets. The Global Drive brands (GDB) grew by combined 4% in terms of volume. These accounted for 27% of the global volume sales for BAT. The overall brand mix for BAT is balanced between premium, mid-price & low-price.
BAT co-ordinate its business with its trading partners to ensure that it is able to meet the demands of the customer at the right place and at the right time. This has worked out well for the company as it helps it maintain the market share in a highly competitive tobacco industry.
BAT regularly surveys their customer base internationally against its peers in the FMCG industry and particularly against its competitors in the tobacco industry. Their efforts got them recognised as the leading business in the tobacco category for customer relationship management by Dow Jones sustainability index for the third successive year in 2009.
For BAT, the Direct Store Sales in the most preferred way of selling cigarettes to customers. It fecilitates greater access to consumer information and market. It has also helped them with a direct commercial link to their most strategic retail accounts. In the FY 2009, total sales volumes distributed through DSS reached 50%.
8. Conclusion
In the words of the Chairman, "We have a clear and consistent strategy and an excellent management team that will maintain sustainable growth and build shareholder value" (Richard Burrows, Annual Report, 2009), British American Tobacco delivered promising results and sustainable growth while other companies struggled in the tough economic climate.
With global economy recovering and tobacco consumption forecasted to increase in the coming years, BAT's outlook looks positive. BAT's geographic diversity, balanced portfolio of brands along with focussed strategy will result in BAT being able to maintain growth and enhance shareholder value.
