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BAT
BAT’s turnover and operating profits increased due to the contribution of ETI (a company acquired at the end of 2003). 2004’s operating profit (before exceptionals and goodwill) of £2.8bn (+1.8%, +7% at CER) increased due to the contribution of ETI; Excluding ETI, BAT’s operating profit would have been 3.9% lower than 2003. The major contributors to the 7.5% increase in volumes were acquisitions and the merger of R J Reynolds with BAT’s US operation Brown and Williamson’s, excluding which, volumes were up only 0.4%.
In the first half BAT reported a 1% reduction in sales of what it classifies as drive brands (Kent, Dunhill, Pall Mall and Lucky Strike). This has more than reversed in the second half with full year volumes up 2%.
The America-Pacific region (28.1% of operating profits) performed poorly. Volumes in the region were up 27%, again mainly a result of the merger. However, operating profits were down 20% as sales fell by 13.5%. Poor market conditions in Japan and Canada and the stronger pound reduced reported turnover.
Profits growth in Europe (+35.5% to £726m; 25.7% of operating profits) was lagely due to the ETI acquisition. Excluding ETI, profit was up 6.1% (+10% at CER). Cigarette markets continued to shrink in Germany, France, Hungary and the Netherlands. BAT has maintained, or slightly improved market share, in a declining market. BAT has increased market share in Russia and Romania, offsetting the profit decline in other countries - overall this should be regarded as an improvement as it shifts sales towards the growth markets in Eastern Europe and away from declining Western European markets.
Revenues from the Asia-Pacific (18.2% of operating profit) region fell by 2.9% on a 4.3% volume increase. However cost savings and better sales mix (i.e. recovery in premium brand sales) in Australia and New Zealand improved operating margin by 3.3 percentage points to 30%. Higher excise duties reduced volumes in Malaysia and and Indonesia.
In the first half results announcement BAT referred to a “major strategic investment” in China. However, BAT wrote of costs that were previously capitalised in relation to the project. BAT does not go into detail, but the Chinese project appears to have cost BAT £50m. This loss may reflect the difficulty in dealing with the Chinese bureaucracy; but may also indicate poor preparation by BAT in entering a new market.
BAT remains the cheapest share in the sector, at a prospective PE of 12.3 (at 976.5p), and a 4.7% yield. This reflects profit growth (2005: +7%) that is wholly driven by cost cutting whereas Gallaher’s lower growth (+5.3%) and Imperial’s (+7.2%) is driven by both sales and cost cuts. BAT has increased its planned target for cost savings from £200m per annum to £320m per annum by 2007, plus additional cost cuts. (£320m is 11.3% of 2004’s operating profit).
During 2004, BAT returned £490m to the shareholders through a share buy back, which will continue. BAT is highly cash generative, as is the other companies in the sector. BAT has a free cash flow per share of 63p which is 84% of 2004’s EPS of 75.8p. Given limited room for growth (and further capex)in the tobacco industry, shareholders can expect a good payouts of cash to continue.
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