Irrational Signals Contribute to Stock Decline at British American Tobacco

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British American Tobacco p.l.c. (BAT) has faced challenges despite a significant dividend payout, leading to concerns among shareholders. The company’s aggressive investments in cannabis and plans to write down U.S. combustible brands signal a shift in its main business line. Despite a recent irrational collapse in stock value, the investment thesis leans slightly bullish as of the end of 2023.

BAT announced an additional investment in Organigram (OGI), reinforcing its commitment to a smokeless world. Despite a previous unsuccessful investment in March 2021, BAT plans to invest an additional £74m (C$125 million) between January 2024 and January 2025, increasing its equity position from 19% to 45%. This move comes as BAT seeks alternative products amid global trends toward smoking bans.

The company recently wrote down U.S. tobacco brands by a massive $31.5 billion, with plans to completely write off these brands, valued at $80 billion, over the next 30 years. This decision, coupled with BAT’s reliance on combustibles for 88% of sales, has raised concerns among shareholders. The CEO’s contradictory statements about the future of cigarettes further added to the uncertainty.

BAT’s investments in Organigram, particularly the 2021 investment that saw a 50% decline, raise questions about the soundness of management’s decisions. Additionally, investing in a Canadian cannabis company without access to the significant U.S. cannabis market diminishes the potential benefits of entering the cannabis space.

Despite forecasting low single-digit organic growth and a 2024 sales target of around 3%, BAT’s stock has experienced a significant decline. The current dividend yield of around 10% suggests value, but the stock trades at only 6x EPS targets, indicating investor concerns. BAT forecasts reaching 50% of sales from non-combustible products by 2035, highlighting a slow transformation despite ambitious plans.

BAT’s struggles highlight the challenges of making large dividend payouts while managing high debt balances. The company increased its dividend payout from £4.6 billion in 2019 to £4.9 billion in 2022, while maintaining a relatively high leverage ratio of 3x. Share buybacks, exceeding $1.0 billion annually, have been viewed as shareholder-friendly but may not be the most prudent move for a company facing growth challenges.

The net debt of £37,259 million and the write-down of valuable brands have spooked the market, raising concerns about BAT’s ability to repay debt. The company’s plan to use excess cash flows for share buybacks and M&A deals should be reconsidered, with a focus on debt reduction to enhance cash flows and reduce interest expenses.

BAT remains attractively priced with a 10% dividend yield, but management must improve messaging to regain investor confidence. Irrational investments in Canadian cannabis and the write-down of U.S. brands have sent negative signals. A more prudent approach, focusing on debt reduction and better capital allocation, could enhance shareholder returns over time. Despite the challenges, BAT’s solid return potential depends on making sound decisions and avoiding unnecessary risks.