The company is struggling with increased social disapproval of smoking in the West and greater regulatory restrictions.
Sales in western Europe and the Americas have continued to decline, as they have across the industry. Overall, global volumes of cigarette sales fell to 676 billion sticks compared with 694 billion in 2012.
Western Europe saw volumes decline the most – by 8.4 per cent. The Americas saw volumes down 6 per cent while volumes rose in Asia by 4.8 per cent.
Encouragingly for investors, profit margins increased by 100 basis points [1 per cent], thanks to cost-cutting and improved productivity.
BAT reported a 7 per cent rise in profits before the effect of exchange rates, which pushed growth down to 3 per cent. A 4 per cent rise in revenues was wiped out by the same currency movements.
The tobacco company’s share price has struggled over the past year, losing 1.77 per cent while the FTSE All Share made almost 14 per cent.
Performance of stock vs index over 1yr
Source: FE Analytics
One of the major reasons for this was the collapse in emerging market currencies where it sells high volumes.
Sheridan Admans (pictured), head of research at The Share Centre, says that the more worrying trend is the decline of sales in Europe and the US.
“It’s an industry that’s subject to lots of regulatory demands and they are only getting tighter and not looser,” he said.
“There’s the threat of plain packaging in the UK, too.”
“For the last couple of years we have seen the whole industry facing a major struggle with falling stick volumes, which has resulted in a lot of them raising prices to combat this.”
One way that BAT has been dealing with this is by tightening its control on costs. A second is by developing new products.
To get around regulations, it has introduced a brand of e-cigarette called Vype, which were first advertised on TV last week.
BAT was the first to come to market with a product, but there are two competitors preparing to launch this year, Admans says.
“How long they will get around the regulation remains to be seen,” he adds.
There has been some talk from the European Parliament that the products should be banned, which explains Admans’ scepticism.
However, in the short-term e-cigarettes have given BAT a route back into TV advertising for the first time in two decades.
The company also seems to have an early advantage in the technology.
Elaine Coverley, head of equity research at Brewin Dolphin, says that the lessons from the American market suggest advertising could give the new products a boost this year, and in the long-run the product could be transformative.
“Demand was strong in 2013 driven by early adopters,” she said.
“We believe high demand growth will be harder to achieve in 2014 as the products are moving into the mainstream.”
“Therefore advertising will be more important to increase consumer awareness. To date, 20 million smokers have tried e-cigarettes, however only 25 per cent of consumers have made repeat purchases and switched from traditional cigarettes to e-cigarettes.”
“E-cigarette sales peaked in August last year, we believe because early adopters were not satisfied with first-generation products.”
“In the US, e-cigarettes have been advertised on TV for a couple of years. Both the Blu brand and NJOY brand have been advertised during the Super Bowl, one of the most expensive advertising slots on US TV, costing around $133,000 a second.”
“Anecdotal evidence would suggest advertising in the US has been successful as Blu and NJOY enjoyed a combined 70 per cent market share in summer 2013.”
“According to the 2014 American E-Cigarette Etiquette Survey, two-thirds of Americans (63 per cent) said they would not be bothered by someone using an e-cigarette in close proximity.”
“At the end of 2013, the e-cigarette market accounted for 1 per cent of the global cigarette industry, accounting for $3bn of sales compared with $700bn from the global tobacco industry.”
“However, expansion could be rapid and one day e-cigarettes could replace cigarettes entirely. No wonder the big tobacco companies are trying to muscle in on the act.”
BAT did not break out revenues from Vype in its most recent results, but the products were only launched last year.
Admans is more sceptical about e-cigarettes, saying that the core business will remain tobacco sales in developed markets.
He does praise the company for its improving return on capital employed [ROCE] over the past decade, however.
This metric measures earnings as a proportion of net assets and equity, showing the return a company can generate from its capital.
The company has done an excellent job of squeezing out returns for shareholders, he says.
BAT’s results note ROCE increased from 23 per cent in 2009 to 31 per cent last year. Share buybacks worth up to £1.5bn are likely to be seen this year, he adds, which on top of a 4.5 per cent yield make the stock attractive enough for the analyst to rate it as a hold for income-seekers.
His scepticism about growth means he won’t go further, however. As Admans highlights, one of the key reasons for the stock’s recent weakness has been currency movements in emerging markets.
It stands to reason that when this reverses, the shares should see some movement in the rebound.
FE Trustnet recently carried comments from a number of emerging market managers claiming that currency falls in the developing world may well have started to bottom out.
Investors should expect currencies to support improving emerging market performance in the latter end of this year, the managers said, which could make now a decent time to buy back into BAT on the cheap.
The stock is trading on a P/E ratio of 18 times, falling to 14.7 times this year.
Blue-chip defensives suffered in the cyclical market of last year and BAT’s troubles are as much due to this short-term trend as to longer-term declines in volumes.
The company has a huge amount of cash on the balance sheet – £2.1bn – and a strong record of cutting costs and increasing profits in the face of regulatory demands.
The shares look like a buy on the grounds that TV advertising and currency reversals should support the company this year.
