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FTSE 100 nicotine products manufacturer British American Tobacco (LSE: BATS) jumped 5% after releasing its 2023 results on 8 February.
This was not surprising, as they looked good, in my view. They also reassured me that my earlier purchase of the stock – primarily for its very high yield – was a good decision.
There remain risks in the shares, of course, as for all listed companies. The key one here is that its transition away from combustible (tobacco) products to non-combustible (vapes and patches) ones is delayed for some reason. Another is any litigation from the effects of its products in the past.
Positive 2023 results
Adjusted profit from operations rose 3.1% in 2023 from 2022 – to £12.47bn. Adjusted diluted earnings per share (EPS) increased 4% over the same period – to 375.6p. And adjusted net debt fell 7.4% – to £33.94bn.
A highlight for me was that although revenue was down 1.3% year on year, New Categories’ revenue jumped by 21%.
These ‘New Categories’ products are the core of the company’s drive to change from combustible to non-combustible products. This is in response to the declining popularity of smoking in developed markets.
The non-combustible products’ profitability aligns with the company’s target to generate at least £5bn in revenues from them by 2025. By 2035, it believes at least half its revenues will come from New Categories products.
Analysts’ expectations are now that its earnings and EPS will rise respectively by 71% and 65.1% a year to end-2026. Return on equity is forecast to be 13.9% by that time.
Additionally very positive for me was news on 2 February of a global settlement deal agreed with Philip Morris International. This resolves all ongoing patent infringement litigation between the two companies related to combustible and non-combustible products.
Undervalued against its peers
Despite the recent price rise on results day, the company’s shares are still down 22% over the past 12 months. They also look very undervalued compared to their peers, in my view.
Starting with the key price-to-earnings (P/E) ratio, the company trades at just 6.2 against a peer group average of 11.2. This comprises Imperial Brands at 7, Altria Group at 8.7, and Philip Morris International at 17.8.
A discounted cash flow analysis shows the stock to be around 43% undervalued at its present price of £24.46.
Therefore, a fair value would be around £42.91, although this does not necessarily mean it will ever reach that level.
Big passive income generator
The company paid a 230.885p per share dividend last year. On the current share price of £24.26, this gives a yield of 9.5%.
If I invested £10,000 now in the stock, I would make £950 this year. Over 10 years, I would have £9,500 to add to my £10,000, if the yield averaged the same.
However, if I reinvested those dividends — ‘dividend compounding’ — rather than spending them, I would have £24,782 after 10 years.
As I bought the stock relatively recently, but at a much better price, I am happy with my position.
Its business prospects look very good, and its shares appear undervalued, in my view. Additionally, it continues to pay a very high yield indeed.
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Simon Watkins has positions in British American Tobacco P.l.c. The Motley Fool UK has recommended British American Tobacco P.l.c. and Imperial Brands Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
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