Top-line1
– Revenue: £12.34Bn (vs. £12.47Bn expected, down -0.8% on an organic basis)
– Revenue from New Categories: £1.65Bn (vs. £1.69Bn expected, up +7.4%)
– Revenue from New Categories: 13.4% of total
– Combustibles revenue: -2.6% (drivers: volume -6.9%, price +7.2%, mix -2.9%); -1.6% if adjusted for the unfavorable US inventory movements
Bottom-line
– Adj. Operating Profit: £5.56Bn (vs. £5.57Bn exp.)
– Adj. Operating Margin: 45.1% (vs. 44.7% exp.)
– New Categories contribution improved by £165Mn and contribution margin improved by 10 bps year-on-year basis (from -2% in H1 2023 to +8% in H1 2024)
– Adj. EPS: £1.69 (vs. £1.66 exp., up +1.3%)
Key Financial Highlights:
– Re-iterates the FY24 guidance and mid-target target: 3-5% revenue and mid single-digit operating profit growth by 2026
– Expects H2 acceleration, driven by the roll-out of product innovations, US commercial actions gaining traction in H1 2024 and the unwind of wholesaler inventory movements
– New Category revenue is likely to be below the £5 billion ambition in 2025 due to the lack of enforcement against illicit single-use vapour products in the US, compounded by the sale of the Russian & Belarusian businesses in 2023
– Adjusted net debt: £32.97 billion (down -11.5% from a year ago). Expects to be within the narrowed leverage target range of 2.0-2.5x adjusted net debt/adjusted EBITDA by year-end 2024
Key Highlights – Product Categories:
– Combustibles: Volume down -6.9%. Resilient performance of combustibles in AME and APMEA (solid volume share growth) offset by the US where the industry volumes remain under pressure, largely driven by macro headwinds and the continued lack of effective enforcement against illicit single-use vapour products. Negative impact of the supply chain disruption in Sudan and market exits in APMEA (largely in Africa).
– Vapor: Volume down -9%. Revenue up +2.6% as pricing more than offset the volume decline. Maintained value share leadership in Top-7 Vapor markets at 40.9%, down 50 bps with gains in Europe more than offset by the US and Canada. Strong pipeline of innovation launched in May 2024, expected to drive accelerated growth in H2.
– Heated Tobacco: Volume down -1%. Revenue down -4%. Volume share declined -20 bps to 16.8% vs. FY23 in Top-9 HTP markets despite the sequential volume share improvement since December 2023. Encouraging early consumer response to glo Hyper Pro device and improved consumables. glo Hyper Pro already launched in 32 markets with premium price positioning. veo (heated herbal product) launched in 19 markets, strongly outperforming competing products.
– Modern Oral: Volume up +52.4%. Specifically,+226% volume growth in the US, driven by the
traction of refreshed Velo brand expression and the national roll-out of Grizzly Modern Oral (real reason: explosive growth mostly related to the ZYN stock-outs). Although the US growth is impressive, AME Region (Europe) delivers the most of the modern oral growth in absolute terms: volume up +45.8% (up more than +800 million pouches) and revenue up +47% (up +£100 million).
– Beyond Nicotine: BAT completed 25 Beyond Nicotine investments since 2020 and continues to invest in innovative, consumer-led brands, new sciences and technologies. Following successful pilot launches, BAT is commencing the national roll-outs of the functional shot brand, Ryde in Australia and Canada
Key Highlights – the US Market (56.3% of the total operating profit):
– Combustibles revenue is down -8.5%, volume is down -13.7% due to the growth of illicit single-use vapor products, weak US macro-economic environment and the deployment of commercial plans including the phasing of wholesaler inventory (expected to fully unwind in H2 2024). Industry volume is down -10%
– US industry volume decline (-10%) = secular decline (-3%) + price/income elasticity (-3.5%) + macro-economic impact (-2.3%) + other/weather (-0.7%) + trade de-stocking (-0.5%)
– BAT combustible volume decline in the US (-13.7%) = Industry decline (-10%) + deep-discount segment growth (-0.9%, a segment in which BAT is not present) + share loss (-0.3%) + unfavorable inventory movements (-2.5%)
– Vapor revenue is down marginally (-0.1%) as pricing (+8.0%) offset -8.1% decline in volume. Illicit single-use vapes are estimated to be more than 50% of the total market. Vuse maintained leadership in value share (closed systems, tracked channels) with 51.2% (-1.1pp).
– BAT welcomes the 3 states that have implemented vapor directories and the additional 10 states that have passed vapour directory and enforcement legislation in 2024. BAT is encouraged by the illicit volume decline in Louisiana following the implementation of legislation with Vuse Alto (up +23%) capturing the majority of volume flowing back to the legal market (up +15.9%)
Acceleration in H2 2024
BAT expects the financial delivery to accelerate to low-single digit revenue and operating profit growth in H2 2024 (from -0.8% and -0.9% in H1 2024, respectively) to meet its FY 24 guidance based on the:
– Reversal of US wholesaler inventory moves
– Majority of the previously announced investments in US commercial initiatives being completed (H1 2024 volume / value share signs of recovery, led by premium)
– Acceleration in New Category growth (innovations in market in all three categories)
– Softer basis of comparison in APMEA and continued strong performance in AME.
FY24 Guidance
– Low-single digit revenue and adjusted profit growth (on an organic basis, at constant currency)
– c.2% transactional and c.4% translational FX headwind on FY24 operating profit
– Global tobacco industry volume expected to be down c.2% with continued weakness in US, France and Sudan, offset by an improving outlook in Turkey and Mexico
– Net finance costs now expected to be ~£1.7 billion, subject to FX and interest rate volatility
– Gross capital expenditure in 2024 of ~£600 million
– Operating cash flow conversion in excess of 90%.
Our take:
BAT’s H1 2024 results are mixed at best, if not somewhat disappointing. Revenue (-0.8%) and operating profit (-0.9%) decline is hard to swallow, although being well expected. At the Pre-Close Update (June 2024), BAT already guided “low-single digit decline in revenue and operating profit” for H1 2024. In terms of operational performance, the key issues persist: cigarette volume decline in the US, under-performance in heated tobacco and competitive / regulatory environment becoming more challenging in e-vapor. Although, all these issues are already well-known and priced in, BAT’s H1 2024 volume performance in both the traditional (combustible: -6.9%) and new/growth (e-vapor: -9%; heated tobacco: -1%) categories is even worse than a low bar of expectations. One bright side in the H1 2024 results: continued nicotine pouches (Velo) growth momentum in the European Region and newfound growth momentum in the key US market (mostly, thanks to the ZYN stock-outs).
All being said, BAT shares added 5% on the day of the announcement – catching many market participants by surprise. There are three broad reasons behind the rally:
(1) Positive market set-up: Since April 2024, tobacco shares are in a strong upward trend. Actually, BAT’s peers have already made new 52-week highs multiple times in this period. The rotation-to-value (-low volatility) trade is especially in full swing over the last two weeks. In the short-run, strong price momentum could prevail by ignoring any bad news or fundamental weaknesses (- remember that when the BAT stock was in a downward trend, BAT investors were frustrated by the lack of positive share price reaction despite multiple good news).
(2) The worse is behind: BAT reported a rare dual revenue – operating profit decline in H1 2024 while guiding single-digit (revenue and operating profit) growth in H2 2024 and 3-5% revenue and mid single-digit operating profit growth by 2026. If we take the guidance granted, BAT’s financial delivery is at the bottom and will improve from here onward. Likewise, BAT’s Management Presentation was dotted with a long list of commercial initiatives (US turnaround investments, glo Hyper pro, Vuse Go 2.0, Vuse Go Reload, etc.) that are expected to bear fruit over the next six months. Thereby, one can find reasons to believe that BAT’s operational delivery is also at the bottom and will improve from here onward.
Separately, BAT shares avoided to break below the October 2023 lows (around $29) in two occasions of major price decline: £25Bn impairment charge announcement for the US combustible brands (December 2023) and the overall market pullback (April 2024). This has significantly increased the market confidence on bottom formation for BAT, marking the end of the 2-year decline trend in April 2024.
Both fundamentally and technically, there are reasons for many market participants to believe that the worse is behind for BAT.
(3) Undemanding valuation: Although Philip Morris International (PMI) has of better-quality assets (brands, technology, people, etc.) than BAT, these two companies have comparable business scope & scale and financial delivery capacity. Obviously, PMI’s business growth performance is superior to that of BAT’s in every metric. Nevertheless, based on the last closing prices, PMI is worth $176 billion – 2.3x BAT ($77 billion) – and, if BAT delivers its promises, the valuation gap between the two companies would become less pronounced over the long-term.
Trading at an undemanding 7.5x P/E, with both the technical and fundamental (e.g. menthol ban, nicotine level reduction, action on illicit vapor, etc.) risk profile improving, BAT is increasingly perceived as an investment with limited downside (with 8.6% dividend yield) and meaningful potential for upside – as its operational and financial performance improves.
Counter price reaction at the LSE market open (expected to be significantly down, but opened flattish) increasingly triggered bid on BAT shares (i.e. “not sold even on bad news”). Heartened by the positive market set-up and prevailing price momentum, market offered credit to BAT for a “Better Tomorrow”. Now, it is up to the BAT Management to deliver the financial and operational improvements promised.
References:
