British American Tobacco (BTI ZA)

Jun 1, 2022 | Stock Picks

SUMMARY

Position:                                               LONG

Upside target:                                 R747.00

Recommended stop-loss:           R644.00

 

Recommendation:                         BUY

 

Analysts:

Peet Serfontein, Thabiso Mamathuba

British American Tobacco is one of the world’s leading tobacco groups, with brands sold in more than 180 markets.  With more than 200 brands in its portfolio, including Dunhill, Kent, and Lucky Strike, BTI makes the cigarette chosen by one in eight of the world’s one billion adult smokers.

The company holds robust market positions in each of its operating regions, enjoys leadership in more than 50 markets, and is regarded as a defensive play with strong brands and pricing power.  The business has also committed to its dividend pay-out, which shows confidence in the outlook and business model.

Technically, the price remains in an inclining channel pattern which makes the share attractive as a speculative investment opportunity (see the black parallel trendlines on the main chart).

Higher highs and higher lows are the most basic form of an inclining channel pattern and are usually bullish in nature.  The expectation is for the price to progress upwards to the upper range of this pattern.  Furthermore, high correlation of the share price relative to a weaker rand also remains of interest.  The share also presents good beta characteristics against the rand.

The price remains above its 200-day simple moving average which is around R580.00. A continued movement above this level supports the bullish long-term trend.

 

Technical analysis

The lower panel shows the occurrences of the Golden Cross signals, indicated by a reading of 1.  Notice it is also the first occurrence since 2013—giving lead to a quality technical signal.

The Golden Cross occurs when a short-term moving average such as the 50-week crosses over a major long-term moving average like the 200-week to the upside.  This usually signals a definitive upward turn in the share price.  In addition, the short-term average trends higher quicker than the long-term average, until they cross (see the insert).

The entry range is between R660.00 to R693.00.  Our upside target is set at R747.00 (+9.5% upside potential from current levels).  This level is just below the upper range of the inclining channel pattern.  An extension to R755.00 seems likely (RSI overbought territory).

Time to exit is mid-July 2022 (taking a medium-term stance).  Keep the option open to close the trade idea should the price reach our profit target in a shorter time.  A price below R644.00 (-5.6% from current levels) remains a major concern for downside potential and is recommended as a stop-loss.  Expect some moderate volatility in the price action.

 

Long-term fundamental view

BTI is regarded as a defensive play with strong brands and pricing power.  The company has also pivoted towards reduced-risk tobacco/nicotine delivery pro-ducts—such as vapour, heated tobacco, snuff, and moist snuff—which has grown to almost a third of sales.  Strong geographic / brand diversity is a key strength with a brand portfolio covering premium, mid-priced, & value-for-money offerings.  BTI also owns Reynolds American, the 2nd-largest US cigarette producer.

Volume growth has been ahead of the rest of the market with Global Drive Brands doing particularly well.  The exposure to emerging markets should support the continuation of this trend.

New Category continues to perform well as consumers continue to switch to non-combustible products, with the division now being a sizeable contributor to group revenue growth.  The division has also started reporting narrowing losses, which further supports its long-term prospects.

Global tobacco industry volumes are ex-pected to fall 2.5% in 2022.  Management has guided for constant currency revenue growth of 3-5% and high single-figure adjusted EPS growth (weighted towards the 2nd half).  Operating cashflow conversion will be over 90%.

Risks to our fundamental view include a sharp deterioration in industry volumes, price competition in key markets, prolonged weak macroeconomic conditions, and forex depreciation within emerging markets.

Sector-specific risks also include regulation and excise tax increases as well as the risk of price wars, which could lead to margin squeeze.  The proposed FDA ban on menthol cigarettes could take years to implement but will hit BTI’s Newport brand.