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7% Yielding British American Tobacco Is The Perfect Bear Market Buy

May 21, 2022

open vaulted gold door

vasilypetkov/iStock via Getty Images

No one is going to accuse 2022 of being a boring year for stocks.

On May 18th, the SP fell 4%, and the Nasdaq almost 5%, the worst day for the market since June 11th, 2020.

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Ycharts

For many popular growth stocks, it's a grisly start to the year.

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Charlie Bilello

But it's always and forever a market of stocks, and do you know what's not falling? British American Tobacco (NYSE:BTI ), which is one of my highest conviction deep value high-yield recommendations of all time.

How on earth can this company be defying market gravity and the worst investor sentiment in 30 years?

There are five reasons why BTI is a Wall Street darling once more. Reasons that could not only help BTI post a strong positive year in 2022 but potentially sets it up for an epic mega rally that could last for the next 10 to 15 years.

Reason One: The Stars Have Aligned For A BTI Mega Rally

Right now the market is obsessed with how many times the Fed is going to hike interest rates (the consensus is 12 times). Well, guess what kinds of companies are least affected by rate hikes? Recession-resistant defensive like tobacco companies.

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Daily Shot

In fact, guess what tends to shine during a Fed tightening cycle? Deep value blue-chips like BTI.

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Daily Shot

Just how long could the BTI rally last this time? For historical context:

  • BTI was recently at its lowest PE in 20 years (8X earnings) just like 2000
  • tech and the market, in general, were recently 23% historically overvalued (vs 50% in March 2000)
  • the Fed was hiking rates in 2000 (14 times)

In other words, today's market conditions are similar to what BTI was facing in early 2000.

So what happened back then?

2000-2002: BTI Was A Tech Crash Darling

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(Source: Portfolio Visualizer Premium)

From the lowest valuations in 20 years, BTI managed to deliver an incredible 134% total return in the tech crash.

  • SP fell 46%
  • Nasdaq 81%
  • growth darlings like Priceline (BKNG) fell as much as 98%

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(Source: Portfolio Visualizer Premium)

BTI was the beneficiary of the 2nd largest growth to value rotation in history during the tech crash.

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(Source: Portfolio Visualizer Premium)

  • 2000: +68%
  • 2001: +14%
  • 2022: +23%

History doesn't repeat itself, but it does rhyme." Mark Twain

Just how strong can BTI's returns be during a secular value supercycle?

BTI Total Returns From March 2000 To May 2017

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(Source: Portfolio Visualizer Premium)

In 2000 BTI was 50% historically undervalued (same as December 2021).

It became 50% overvalued by 2017, while delivering Buffett-like 24% annual returns that generated 39X returns, 27X adjusted for inflation.

  • almost 3X the returns of Amazon
  • and 16X better returns than the SP 500
  • 27X better returns than the Nasdaq

Was this kind of incredible return a fluke?

BTI Total Returns Since May 1985

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(Source: Portfolio Visualizer Premium)

BTI has been outperforming the market for over 30 years, delivering 120X returns since mid-1985.

  • 44X inflation-adjusted returns
  • 2.5X better than the SP 500

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(Source: Portfolio Visualizer Premium)

BTI has been generating 14% to 15% market-crushing returns for decades, and that's likely to continue.

Why am I confident that BTI's recovery to fair value is just getting started?

BTI Investment Thesis Is Intact

Metric 2020 Growth 2021 Growth Consensus 2022 Growth Consensus 2023 Growth Consensus 2024 Growth Consensus

2025 Growth Consensus

Sales 0% 7% 0% 4% 5% 7% Dividend 6% 1% 12% 7% (25-year dividend growth streak) 7% 2% EPS 10% -3% (currency effects) 3% 10% 9% 8% Operating Cash Flow 9% 11% 7% 7% 8% 1% Free Cash Flow 21% -2% 12% 2% 15% 7% EBITDA 2% 6% 1% 6% 5% NA EBIT (operating income) 3% 4% 3% 6% 5% NA

(Source: FAST Graphs, FactSet)

BTI is a recession-resistant defensive tobacco giant whose growth thesis remains firmly intact.

Reason Two: British American Is The Complete Package You Can Trust In This Bear Market

Here's the bottom line upfront on BTI.

Bottom Line Up Front

  • a UK company
  • zero dividend tax withholding
  • $.02 per year in ADR fees

Reasons To Potentially Buy BTI Today

  • 84% quality low-risk 13/13 Ultra SWAN tobacco global aristocrat
  • 82% dividend safety score
  • 0.5% average recession cut risk
  • 2.0% severe recession cut risk
  • 6.9% very safe yield
  • 23-year dividend growth streak (at least) - global aristocrat by SP standards
  • 36% conservatively undervalued (potential Ultra Value buy)
  • Fair Value: $66.26 (13.9X earnings)
  • 9.0X forward earnings vs 13X to 14X historical
  • 9.0X cash-adjusted earnings
  • BBB+ negative outlook credit rating = 5% 30-year bankruptcy risk
  • 72nd industry percentile risk management consensus = good
  • 6% to 10% CAGR growth consensus range
  • 8.0% CAGR median growth consensus
  • 7% to 9% management guidance
  • 5-year consensus total return potential: 17% to 22% CAGR
  • base-case 5-year consensus return potential: 19% CAGR (4X SP consensus)
  • consensus 12-month total return forecast: 31% (11.1 PE)
  • Fundamentally Justified 12-Month Returns: 62% CAGR

BTI Long-Term Consensus Total Return Potential

Investment Strategy Yield LT Consensus Growth LT Consensus Total Return Potential Long-Term Risk-Adjusted Expected Return Long-Term Inflation And Risk-Adjusted Expected Returns Years To Double Your Inflation Risk-Adjusted Wealth

10 Year Inflation And Risk-Adjusted Expected Return

British American Tobacco 6.9% 8.00% 14.9% 10.4% 7.9% 9.1 2.14 Safe Midstream 5.6% 6.0% 11.6% 8.1% 5.6% 12.9 1.72 Adam's Planned Correction Buys 4.1% 19.2% 23.3% 16.3% 13.8% 5.2 3.63 10-Year US Treasury 2.9% 0.0% 2.9% 2.9% 0.4% 205.7 1.04 High-Yield 2.8% 10.3% 13.1% 9.2% 6.6% 10.9 1.90 REITs 2.8% 6.5% 9.3% 6.5% 4.0% 18.2 1.47

(Sources: Morningstar, FactSet, Ycharts)

  • analysts expect BTI to beat almost all high-yield investment strategies on Wall Street in the long-term
  • including the REITs, midstream, and high-yield blue-chips

What do analysts expect in the future?

Inflation-Adjusted Consensus Return Potential: $1,000 Initial Investment

Time Frame (Years) 7.7% CAGR Inflation-Adjusted SP Consensus 8.7% Inflation-Adjusted Aristocrat Consensus 12.4% CAGR Inflation-Adjusted BTI Consensus Difference Between Inflation Adjusted BTI Consensus And SP Consensus 5 $1,445.67 $1,514.08 $1,790.05 $344.38 10 $2,089.97 $2,292.44 $3,204.28 $1,114.31 15 $3,021.42 $3,470.93 $5,735.83 $2,714.41 20 $4,367.98 $5,255.26 $10,267.42 $5,899.44 25 $6,314.67 $7,956.89 $18,379.21 $12,064.54 30 $9,128.95 $12,047.36 $32,899.73 $23,770.77

(Source: DK Research Terminal, FactSet)

Over the next 30 years, management and analysts both expect about 33X inflation-adjusted returns, far more than what the SP is expected to deliver.

Time Frame (Years) Ratio Aristocrats/SP 500 Ratio Inflation-Adjusted Low Volatility Aristocrat Consensus And SP Consensus 5 1.05 1.24 10 1.10 1.53 15 1.15 1.90 20 1.20 2.35 25 1.26 2.91 30 1.32 3.60

(Source: DK Research Terminal, FactSet)

BTI could potentially beat the market by 4X over the coming decades turning a modest investment today into a medium-sized fortune.

But you don't need to wait 30 years to earn impressive returns with BTI.

BTI 2024 Consensus Total Return Potential

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(Source: FAST Graphs, FactSet)

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(Source: FAST Graphs, FactSet)

(Source: FAST Graphs, FactSet)

If BTI grows as analysts expect by 2024 it could deliver 95% total returns, or 29% annually.

  • Buffett-like returns from a red hot blue-chip bargain

BTI 2027 Consensus Total Return Potential

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(Source: FAST Graphs, FactSet)

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(Source: FAST Graphs, FactSet)

By 2027 if BTI grows as expected (7.6% CAGR) and returns to historical fair value, it could deliver 169% total returns or 19% annually.

  • almost 4X the SP 500 consensus
  • Buffett-like returns for the next five years

BTI Investment Decision Score

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DK

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(Source: DK Automated Investment Decision Tool)

For anyone comfortable with its risk profile, BTI is one of the most reasonable and prudent hyper-growth Ultra SWANs you can buy today.

  • 36% discount vs 1% market premium = 37% better valuation
  • 4X higher yield (and a much safer yield at that)
  • 50% higher long-term return potential than SP 500 overtime
  • about 2X better risk-adjusted expected return over the next five years

Reason Three: World-Class Quality You Can Trust In All Market Conditions

There are many ways to measure safety and quality and I factor in pretty much all of them.

The Dividend Kings' overall quality scores are based on a 248-point model that includes:

  • Dividend safety

  • Balance sheet strength

  • Credit ratings

  • Credit default swap medium-term bankruptcy risk data

  • Short and long-term bankruptcy risk

  • Accounting and corporate fraud risk

  • Profitability and business model

  • Growth consensus estimates

  • Management growth guidance

  • Historical earnings growth rates

  • Historical cash flow growth rates

  • Historical dividend growth rates

  • Historical sales growth rates

  • Cost of capital

  • GF Scores

  • Long-term risk-management scores from MSCI, Morningstar, FactSet, SP, Reuters'/Refinitiv, and Just Capital

  • Management quality

  • Dividend friendly corporate culture/income dependability

  • Long-term total returns (a Ben Graham sign of quality)

  • Analyst consensus long-term return potential

In fact, it includes over 1,000 fundamental metrics including the 12 rating agencies we use to assess fundamental risk.

  • credit and risk management ratings make up 41% of the DK safety and quality model

  • dividend/balance sheet/risk ratings make up 82% of the DK safety and quality model

How do we know that our safety and quality model works well?

During the two worst recessions in 75 years, our safety model 87% of blue-chip dividend cuts, the ultimate baptism by fire for any dividend safety model.

How does BTI score on our comprehensive safety and quality models?

BTI Dividend Safety

Rating Dividend Kings Safety Score (166 Point Safety Model) Approximate Dividend Cut Risk (Average Recession)

Approximate Dividend Cut Risk In Pandemic Level Recession

1 - unsafe 0% to 20% over 4% 16+% 2- below average 21% to 40% over 2% 8% to 16% 3 - average 41% to 60% 2% 4% to 8% 4 - safe 61% to 80% 1% 2% to 4% 5- very safe 81% to 100% 0.5% 1% to 2% BTI 82% 0.5% 2.00% Risk Rating Low-Risk (72nd industry percentile risk-management consensus) BBB+ Negative outlook credit rating 5% 30-year bankruptcy risk

15% OR LESS Max Risk Cap Recommendation (each)

Long-Term Dependability

Company DK Long-Term Dependability Score Interpretation Points Non-Dependable Companies 21% or below Poor Dependability 1 Low Dependability Companies 22% to 60% Below-Average Dependability 2 SP 500/Industry Average 61% (61% to 70% range) Average Dependability 3 Above-Average 71% to 80% Very Dependable 4 Very Good 81% or higher Exceptional Dependability 5 BTI 86% Exceptional Dependability 5

Overall Quality

BTI Final Score Rating Safety 83% 5/5 very safe Business Model 80% 3/3 wide moat Dependability 86% 5/5 exceptional Total 84% 13/13 Ultra SWAN global aristocrat Risk Rating 3/3 Low Risk 20% OR LESS Max Risk Cap Rec

5% Margin of Safety For A Potentially Good Buy

Why I Trust British America And So Can You

BTI was founded in 1902 in London and is the largest tobacco company in the world by sales.

But BTI's future is in smoke-free reduced-risk products.

For the last three years, BTI's reduced-risk or RRP sales have been growing at 32% annually, while its RRP userbase has grown at 31% CAGR.

  • RRPs now make up 14% of sales
  • up from 5% in 2019 and 8% in 2020
  • up to 72% of sales in Sweden

BTI's RRP customers have been growing steadily.

  • +2.5 million in 2019
  • +3.0 million in 2020
  • +4.8 million in 2021

They were 18.3 million at the end of 2021 and by 2025 management plans to get that to 50 million.

BTI's legacy cigarette sales growth has been steady at 3% and with RRPs has driven just over 5% sales growth over the last three years.

  • during its 2nd worst bear market in history
  • which began when it was 50% historically overvalued and trading at 21X earnings

BTI has a goal of 7% to 9% EPS growth over time driven by steady sales growth, cost-cutting ($1.6 billion in cost-cutting delivered a year early), and buybacks.

In 2021 the company achieved 51% growth in RRPs and hit its de-leveraging target of 3.0X debt to adjusted EBITDA.

  • $2.5 billion buyback authorization is now in effect

Since buying the rest of Reynolds in 2018, BTI has very steadily reduced its debt/EBITDA by 0.4 turns per year, while delivering an average cash flow conversion (cash flow/earnings) of 101%.

  • 104% in 2021
  • cash flow is what actually pays the dividends

While RRPs are still losing money, the company cut its RRP losses in 2021 by $125 million.

BTI's goal is to grow RRP sales by 25% annually to $6.25 billion by 2025, hitting 15% of total company sales.

  • it also expects RRPs to become profitable that year
  • 50 million RRP customers vs 18 million today
  • BTI is likely being conservative since RRP is already 14% of sales

BTI has a clear plan for how to deliver that RRP profitability.

  • cut costs by $125 million in 2021
  • cutting costs of goods by 22% through automation
  • cutting customer acquisition costs by 25% to 47% depending on the brand (more effective social media and marketing)

BTI's RRPs have been found to be 95% to 99% less harmful than traditional tobacco products.

  • confirmed by 156 peer-reviewed studies

BTI RRP safety has also been confirmed by regulators in the UK, France, EU, and the US.

Between 41% and 53% of cigarette users who try BTI's RRPs permanently quit smoking.

  • compared to less than 10% for traditional smoking cessation programs
  • not as good as PM's 70% but still 4X to 5X better than the alternative

This is partially why BTI's long-term risk management on everything from smoke-free transition to emissions, to supply chain and labor relations is industry-leading.

  • high-risk management scores from Morningstar
  • SP (86th industry percentile) - gold class rating for 2022
  • MSCI
  • Dow Jones (20 consecutive years it Dow Jones strong ESG index)
  • ISS (#1 proxy consultation on earth) - #1 in its industry
  • Reuters/Refinitiv
  • Gartner
  • Financial Times

BTI owns the #1, #2, or #3 global vaping and oral nicotine brands and has slowly been gaining market share in recent years.

RRPs make up a significant portion of developed market sales.

  • 72% in Sweden (Up from 63% in 2020)
  • 47% in Japan (up from 42% in 2020)
  • 38% in the UK (up from 28% in the UK)
  • 33% in Norway (up from 27% in 2020)
  • 14% in the US (up from 13% in 2020)

What about the Russian-Ukrainian war?

  • 3% of sales are from these countries
  • even less of its profits
  • not a significant threat to the investment thesis
  • PM is far more affected (PM's growth consensus has fallen about 75% since the invasion)

BTI's RRP brands are rapidly gaining market share.

For example, in 2021 single year Vuse market share gains were:

  • +7.6% in the US to 32.5%
  • +34.3% in Canada to 80.4%
  • +2.1% in the UK to 16.9%
  • +14.2% in France to 45.7%
  • +10.1% in Germany to 59.9%

Glo heat sticks also saw market share growth in 2021:

  • +1.8% in Japan to 21.2%
  • +8.7% in Italy to 12.8%
  • +8.7% in France to 12.8%
  • +5.3% in Romania to 22.1%

Velo nicotine pouches market share is also strong and growing:

  • +4.1% in the US to 11.7%
  • +5.8% in Sweden to 59.6%
  • -1.3% in Denmark to 92.6%
  • -3.4% in Switzerland to 91.5%
  • +1.8% in Norway to 63.9%

In markets where market share is shrinking modestly, it's doing so because market share is over 90%.

The company's venture capital arm, Btomorrow Ventures, is investing in cannabis, having already closed 17 deals to date.

In the US, which is 46% of BTI's sales, cigarettes make up 83% of sales.

  • 10% chewing tobacco
  • 7% vaping
  • 1% nicotine pouches
  • 0% heat sticks (for now)

The company expects vaping, specifically Vuse, to be its key growth driver in the next five years.

In the last two years, BTI has stolen Altria's Juul market share which fell from 54.5% in 2020 to 36% by the end of 2021.

  • BTI's Vuse is up to 35.9%, 0.1% behind Juul
  • BTI has won 27% market share in 2 years
  • 7.6% in 2021
  • and is on the verge of becoming the #1 name in vaping in the US

The US is one of BTI's more mature vaping markets and in the 2nd half of 2021, it achieved profitability for the first time.

  • 40% CAGR sales growth in Vuse in the US over the last two years

Glo, BTI's heat stick brand, saw 195% volume growth in 2021 and 167% revenue growth.

  • some pricing competition from PM

Overall in 2021 BTI had very strong results:

  • 6.9% sales growth
  • 0.2% market share gains
  • 4.3% price increases
  • 0.3% volume declines
  • 5.2% growth in operating profits
  • 6.6% growth in EPS
  • 51% growth in RRPs

BTI is executing well on its long-term plans to deliver 7% to 9% EPS growth.

  • analysts now expect 8%
  • mid-range of management guidance

BTI expects to generate $50 billion in free cash flow over the next five years and its capital allocation priorities are:

  1. growing the business
  2. growing the dividend (23+ year dividend growth streak)
  3. keeping debt/EBITDA between 2 to 3 (2.5 midrange vs 3.0 or less safe according to rating agencies)
  4. bolt-on MA
  5. buybacks

Over the next five years BTI expects to deliver:

  • $6.25 billion in annual RRP revenue by 2025
  • invest in cannabis
  • 3% to 5% annual sales growth
  • 7% to 9% EPS growth (highest of the tobacco giants)

Quantitative Analysis: The Math Backing Up BTI's Investment Thesis

BTI has a clear vision for how it can continue delivering historical growth of 7% to 9% in the coming years and decades.

And here's the math backing that up.

BTI Credit Ratings

Rating Agency Credit Rating 30-Year Default/Bankruptcy Risk Chance of Losing 100% Of Your Investment 1 In SP BBB+ Negative Outlook 5.00% 20.0 Fitch BBB Stable Outlook 7.50% 13.3 Moody's Baa2 (BBB equivalent) Stable Outlook 7.50% 13.3 Consensus BBB Stable Outlook 6.67% 15.0

(Source: SP, Moody's)

Rating agencies estimate a 6.7% risk of BTI going bankrupt over the next 30 years.

  • 1 in 15 fundamental risk of losing all your money

SP recently downgraded to a negative outlook indicating a 33% chance of a downgrade to BBB stable (just like Moody's and Fitch have).

  • over the announced buyback, which will slow future de-leveraging

BTI Leverage Consensus Forecast

Year Debt/EBITDA Net Debt/EBITDA (3.0 Or Less Safe According To Credit Rating Agencies)

Interest Coverage (8+ Safe)

2020 3.65 3.37 6.73 2021 3.31 3.08 7.76 2022 3.11 2.91 7.98 2023 2.90 2.65 8.85 2024 2.71 2.41 10.02 2025 2.77 1.81 15.08 Annualized Change -5.38% -11.72% 17.52%

(Source: FactSet Research Terminal)

Despite the buyback authorization analysts expect BTI's leverage to keep falling over time, just at a more modest pace.

  • stabilizing at about 2.8X in 2025
  • 1.8X on a net basis

Interest coverage is expected to keep rising up to 15X by 2025, almost double the rating agency safety guideline for this industry.

BTI Balance Sheet Consensus Forecast

Year Total Debt (Millions) Cash Net Debt (Millions) Interest Cost (Millions) EBITDA (Millions) Operating Income (Millions) Average Interest Rate 2020 $61,283 $4,660 $56,567 $2,340 $16,789 $15,746 3.82% 2021 $53,586 $3,796 $49,790 $1,954 $16,173 $15,167 3.65% 2022 $50,863 $5,197 $47,624 $1,913 $16,379 $15,262 3.76% 2023 $50,154 $6,626 $45,873 $1,823 $17,294 $16,130 3.63% 2024 $49,386 $9,339 $43,886 $1,702 $18,206 $17,050 3.45% 2025 $53,586 $23,902 $34,976 $1,199 $19,358 $18,086 2.24% Annualized Growth -2.65% 38.68% -9.17% -12.52% 2.89% 2.81% -10.14%

(Source: FactSet Research Terminal)

BTI's debt has been drifting lower for several years and is expected to be about $54 billion by 2025.

Cash is growing rapidly as well and net debt is falling at 9% per year. Interest costs are expected to remain stable or decline as the balance sheet gets steadily safer.

Cash flows are expected to grow at about 3% annually.

BTI Bond Profile

  • $24.4 billion in liquidity
  • well-staggered bond maturities (no issues refinancing maturing debt)
  • 99.2% unsecured bonds (maximum financial flexibility)
  • bond investors are so confident in BTI's smoke-free future that they are willing to lend to it for 34 years at 6% vs FCF margins of 35%
  • average borrowing costs 3.31%
  • average maturity: 10.1 years
  • 68% priced in dollars, 13% in pounds, 13% in Euros, and 6% in other currencies
  • 0.76% inflation-adjusted borrowing costs vs 6.4% returns on invested capital

BTI Credit Default Swaps: Real-Time Fundamental Risk Assessment From The Bond Market

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(Source: FactSet Research Terminal)

Credit default Swaps are insurance policies bond investors take out against defaults and represent a real-time fundamental update of a company's risk profile.

  • when scary headlines break watch the CDS to see how concerned the "smart money" is about fundamental risk

BTI's fundamental risk has seen significant increases in recent months, mostly surrounding the Russian invasion. It's still low in absolute terms and in the past week has been declining.

  • 0.3618% over the next year
  • 1.13% over the next five years
  • 1.6594% over the next 10 years
  • 4.98% over the next 30 years = same as Moody's and Fitch estimate
  • consistent with a BBB stable credit rating

The bond market is basically agreeing with analysts and rating agencies that BTI's thesis remains intact.

BTI GF Score: The Newest Addition To The DK Safety And Quality Model

The GF Score is a ranking system that has been found to be closely correlated to the long-term performances of stocks by backtesting from 2006 to 2021." - Gurufocus

GF Score takes five key aspects into consideration. They are:

  • Financial Strength
  • Profitability
  • Growth
  • Valuation
  • Momentum

BTI's very strong 83/100 GF score confirms it's an industry leader in everything that matters.

  • industry-leading profitability
  • industry-leading financial strength
  • industry-leading growth
  • industry-leading value

BTI Profitability: Wall Street's Favorite Quality Proxy

Historical profitability is in the top 10% of peers.

BTI Trailing 12-Month Profitability Vs Peers

Metric Industry Percentile Major Tobacco Companies More Profitable Than BTI (Out Of 48) Gross Margins 95.56 2 Operating Margin 93.48 3 Net Margin 84.78 7 Return On Equity 40.00 29 Return On Assets 35.42 31 Returns On Invested Capital 41.67 28 Return On Capital 83.33 8 Return On Capital Employed 34.09 32 Average 58.97 20

(Source: Gurufocus Premium)

In the last year, BTI's profitability was impacted by supply chain issues and now the Russian invasion.

  • Its operating profitability remains in the top 17% of peers or better

BTI's industry-leading profitability has been relatively stable for 30 years, confirming a wipe and stable moat.

  • returns on equity and assets and capital employed fell after the Reynolds's acquisition
  • but operating margins, net margins, and free cash flow margins have been rising in recent years as that major acquisition pays off

BTI Profit Margin Consensus Forecast

Year FCF Margin EBITDA Margin EBIT (Operating) Margin Net Margin Return On Capital Expansion

Return On Capital Forecast

2020 28.7% 47.0% 44.1% 29.5% 1.10 2021 26.8% 43.1% 40.5% 27.4% TTM ROC 196.83% 2022 31.0% 47.4% 44.1% 30.2% Latest ROC 193.21% 2023 32.2% 47.9% 44.7% 31.0% 2025 ROC 217.31% 2024 32.3% 48.2% 45.2% 31.7% 2025 ROC 213.31% 2025 32.5% 47.8% 44.7% 32.2% Average 215.31% 2026 NA NA NA NA Industry Median 60.89% 2027 NA NA NA NA BTI/Industry Median 3.54 Annualized Growth 3.06% 0.64% 0.26% 1.75% Vs SP 14.75 Annualized Growth (Ignoring Pandemic) 6.50% 3.78% 2.51% 4.12%

(Source: FactSet Research Terminal)

Analysts expect BTI's margins to keep rising at healthy rates through 2025 including free cash flow margins growing 6.5% ignoring the pandemic effects.

  • return on capital = annual pre-tax profit/all the money it takes to run the business
  • Joel Greenblatt's gold standard proxy for quality and moatiness

Returns on capital are expected to increase to 3.5X its industry peers and almost 15X that of the SP 500.

BTI's ROC has been growing at 7% annually over 30 years, roughly doubling every decade, confirming a wide and stable moat.

Reason Four: A Solid Plan For Industry-Leading Growth

Many people think BTI is a dying company simply because cigarette volumes have been falling for 50 years.

BTI Medium-Term Growth Consensus Forecast

Year Sales Free Cash Flow EBITDA EBIT (Operating Income) Net Income 2020 $35,711 $10,233 $16,789 $15,746 $10,547 2021 $37,491 $10,036 $16,173 $15,167 $10,278 2022 $34,587 $10,709 $16,379 $15,262 $10,451 2023 $36,072 $11,633 $17,294 $16,130 $11,182 2024 $37,755 $12,207 $18,206 $17,050 $11,960 2025 $40,493 $13,159 $19,358 $18,086 $13,045 Annualized Growth 2.55% 4.51% 2.05% 2.81% 4.34% Annualized Growth (Ignoring Pandemic) 1.94% 6.75% 4.03% 4.50% 6.14% Cumulative Over The Next 4 Years $148,907 $47,708 $71,237 $66,528 $46,638

(Source: FactSet Research Terminal)

Analysts don't expect BTI to achieve its 4% sales growth goal but they do expect steady growth in the top and bottom line and free cash flow to surpass management's $50 billion guidance by about $10 billion.

  • analyst consensus about $60 billion in FCF over the next five years

BTI Dividend Potential Consensus Forecast

Year Dividend Consensus FCF/Share Consensus FCF Payout Ratio Retained (Post-Dividend) Free Cash Flow Buyback Potential Debt Repayment Potential 2022 $2.98 $4.97 60.0% $4,567 5.72% 8.5% 2023 $3.19 $5.23 61.0% $4,682 5.87% 9.2% 2024 $3.42 $5.96 57.4% $5,829 7.31% 11.5% 2025 $3.49 $6.37 54.8% $6,610 8.28% 13.2% Total 2022 Through 2025 $13.08 $22.53 58.1% $21,687.75 27.18% 42.64% Annualized Rate 5.41% 8.62% -2.96% 13.11% 13.11% 15.64%

(Source: FactSet Research Terminal)

Rating agencies consider 85% FCF payout ratios to be safe for this industry.

  • BTI has a 65% EPS payout ratio policy
  • PM 75%
  • MO 80%

BTI's FCF payout ratio is expected to average 58% through 2025 and fall to 55% by 2025.

  • the best-covered dividend in the industry

Almost $22 billion in post-dividend retained free cash flow is enough to pay off 43% of its debt or buy back up to 27% of shares at current valuations.

BTI Buyback Consensus Forecast

Year Consensus Buybacks ($ Millions) % Of Shares (At Current Valuations) Market Cap 2022 $2,617.0 3.3% $79,683 2023 $3,467.0 4.4% $79,683 2024 $3,744.0 4.7% $79,683 Total 2022-2023 $9,828.00 12.3% $79,683 Annualized Rate 4.43% Average Annual Buybacks $3,276.00

(Source: FactSet Research Terminal)

While management has only authorized $2.5 billion in buybacks analysts expect BTI to buy back almost $10 billion in stock in the next three years.

  • an average annual net rate of 4.4% at current valuations

BTI is opportunistic with buybacks at times repurchasing 10% or more in a single year, and other times issuing stock to make big acquisitions, like Reynolds.

Time Frame (Years) Net Buyback Rate Shares Remaining Net Shares Repurchased Each Share You Own Is Worth X Times More (Not Including Future Growth And Dividends) 5 4.4% 79.73% 20.27% 1.25 10 4.4% 63.56% 36.44% 1.57 15 4.4% 50.68% 49.32% 1.97 20 4.4% 40.40% 59.60% 2.47 25 4.4% 32.21% 67.79% 3.10 30 4.4% 25.68% 74.32% 3.89

(Source: FactSet Research Terminal)

If BTI buys back stock at the expected rate then over the next 30 years they could repurchase almost 75% of their stock.

  • boosting the intrinsic value of your shares by almost 4X
  • not counting dividend and earnings growth over that time

BTI Long-Term Growth Outlook

  • 8.0% to 8.9% CAGR consensus range (five sources)
  • 8.0% median growth consensus from all 18 analysts

How accurate are analysts at forecasting BTI's growth over time?

Smoothing for outliers historical margins of error are 10% to the upside and 20% to the downside.

  • 6% to 10% CAGR historical margin-of-error adjusted growth consensus range
  • 70% statistical probability that BTI grows at 6% to 10% over time

Over the past 20 years, BTI's growth ranged from -2.6% to 8.4%, and with buybacks alone capable of funding up to 8% growth, analysts are confident BTI can grow at 8%.

  • similar to the growth rate of the last 20 years
  • and mid-range management guidance

Reason Five: Still A Table Pounding Great Buy

For 20 years, outside of bear markets and bubbles, tens of millions of income investors have consistently paid 13 to 14X earnings for BTI.

  • 91% statistical probability that this range includes intrinsic value

Metric Historical Fair Value Multiples (all years) 2021 2022 2023 2024 2025

12-Month Forward Fair Value

25-year Average Yield 4.29% $68.76 $69.00 $69.00 $80.19 $82.98 Earnings 13.40 $60.03 $61.77 $67.40 $73.30 $79.46 Average $64.10 $65.19 $68.19 $76.59 $81.18 $66.28 Current Price $42.75

Discount To Fair Value

33.31% 34.42% 37.31% 44.18% 47.34% 35.50%

Upside To Fair Value (NOT Including Dividends)

49.95% 52.48% 59.51% 79.15% 89.91% 55.05% (62% including dividend) 2022 EPS 2023 EPS 2022 Weighted EPS 2023 Weighted EPS 12-Month Forward EPS 12-Month Average Fair Value Forward PE

Current Forward PE

$4.61 $5.03 $2.93 $1.84 $4.76 13.9 9.0

I estimate BTI is worth about 14X earnings, and today it trades at just 9.0X and 9.0X cash-adjusted earnings.

  • if BTI went up 55% in the next year that would merely be returning to fair value

Analyst Median 12-Month Price Target

Morningstar Fair Value Estimate

$52.99 (11.1 PE) $50.00 (10.5 PE)

Discount To Price Target (Not A Fair Value Estimate)

Discount To Fair Value

19.32% 14.50%

Upside To Price Target (Not Including Dividend)

Upside To Fair Value (Not Including Dividend)

23.95% 16.96%

12-Month Median Total Return Price (Including Dividend)

Fair Value + 12-Month Dividend

$55.95 $52.96

Discount To Total Price Target (Not A Fair Value Estimate)

Discount To Fair Value + 12-Month Dividend

23.59% 19.28%

Upside To Price Target ( Including Dividend)

Upside To Fair Value + Dividend

30.88% 23.88%

Morningstar's fair value model is based on a DCF model that pegs BTI's fair value multiple at 10.5.

  • 91% statistically likely to be too conservative
  • BTI's historical market-determined fair value is 13 to 14X

Yet even Morningstar thinks BTI has 24% upside to fair value and analysts expect 31% total returns in just the next year alone.

I don't actually care about 12-month price forecasts only whether or not the current margin of safety sufficiently compensates investors for the risk profile.

Rating Margin Of Safety For Low-Risk 13/13 Ultra SWAN quality companies 2022 Price 2023 Price

12-Month Forward Fair Value

Potentially Reasonable Buy 0% $65.19 $68.19 $66.28 Potentially Good Buy 5% $61.93 $64.78 $62.97 Potentially Strong Buy 15% $55.41 $57.96 $56.34 Potentially Very Strong Buy 25% $46.45 $51.14 $49.71 Potentially Ultra-Value Buy 35% $42.37 $44.32 $43.08 Currently $42.75 34.42% 37.31% 35.50% Upside To Fair Value (Not Including Dividends) 52.48% 59.51% 55.05%

At a 35% discount, BTI is a potentially Ultra Value strong buy for anyone comfortable with its risk profile.

Risk Profile: Why British American Isn't Right For Everyone

There are no risk-free companies and no company is right for everyone. You have to be comfortable with the fundamental risk profile.

What Could Cause BTI's Investment Thesis To Break

  • safety falls to 40% or less
  • balance sheet deteriorates (possibly due to a large acquisition)
  • smoke-free future transition plan fails (possibly due to PM dominating the market)
  • growth outlook falls to less than 1.1% for seven years
  • BTI's role in my portfolio is to deliver long-term 8+% returns with minimal fundamental risk

How long it takes for a company's investment thesis to break depends on the quality of the company.

Quality

Years For The Thesis To Break Entirely

Below-Average 1 Average 2 Above-Average 3 Blue-Chip 4 SWAN 5 Super SWAN 6 Ultra SWAN 7 100% Quality Companies (MSFT, LOW, and MA) 8

These are my personal rule of thumb for when to sell a stock if the investment thesis has broken.

BTI is highly unlikely to suffer such catastrophic declines in fundamentals.

BTI's Risk Profile Includes

  • regulatory risk (global and US) - plain packaging laws, menthol ban, nicotine level regulation, RRP tax policies, RRP approvals
  • smoke-free transition risk (PM is the industry leader)
  • margin risk: RRP is currently unprofitable
  • MA execution risk (BTI tends to make occasional giant deals)
  • labor retention risk (tightest job market in over 50 years and finance is a high paying industry)
  • currency risk (including for dividends)
  • interest rate risk: rolling over debt at potentially much higher interest rates (could cause growth to come in lower than currently expected)

How do we quantify, monitor, and track such a complex risk profile? By doing what big institutions do.

Long-Term Risk Analysis: How Large Institutions Measure Total Risk

  • see the risk section of this video to get an in-depth view (and link to two reports) of how DK and big institutions measure long-term risk management by companies

BTI Long-Term Risk Management Consensus ​

Rating Agency Industry Percentile

Rating Agency Classification

MSCI 37 Metric Model 58.0%

BBB, Average, Negative Trend

Morningstar/Sustainalytics 20 Metric Model 85.6%

26.8/100 Medium-Risk

Reuters'/Refinitiv 500+ Metric Model 99.5% Excellent SP 1,000+ Metric Model 86.0%

Very Good, Stable Trend

FactSet 50.0%

Average, Positive Trend

Morningstar Global Percentile (All 15,000 Rated Companies) 50.5% Average Consensus 72%

Low-Risk, Good Risk-Management, Stable Trend

(Sources: MSCI, Morningstar, SP, FactSet, Reuters)

BTI's Long-Term Risk Management Is The 163rd Best In The Master List (67th Percentile)

Classification Average Consensus LT Risk-Management Industry Percentile

Risk-Management Rating

SP Global (SPGI) #1 Risk Management In The Master List 94 Exceptional Strong ESG Stocks 78

Good - Bordering On Very Good

Foreign Dividend Stocks 75 Good British American Tobacco 72 Good Ultra SWANs 71 Good Low Volatility Stocks 68 Above-Average Dividend Aristocrats 67 Above-Average Dividend Kings 63 Above-Average Master List average 62 Above-Average Hyper-Growth stocks 61 Above-Average Monthly Dividend Stocks 60 Above-Average Dividend Champions 57 Average

(Source: DK Research Terminal)

BTI's risk-management consensus is in the top 33% of the world's highest quality companies and similar to that of such other blue-chips as

  • Caterpillar (CAT) - dividend aristocrat
  • Enbridge (ENB) - global dividend aristocrat
  • Stanley Black Decker (SWK) - dividend king
  • NextEra Energy (NEE) - dividend aristocrat
  • McCormick (MKC) - dividend aristocrat
  • Canadian National Railway (CNI) - global aristocrat
  • Cisco (CSCO)
  • Northrup Grumman (NOC)

The bottom line is that all companies have risks, and BTI is good at managing theirs.

How We Monitor BTI's Risk Profile

  • 18 analysts
  • 3 credit rating agencies
  • 5 total risk rating agencies
  • 26 experts who collectively know this business better than anyone other than management
  • and the bond market for real-time fundamental risk assessments

When the facts change, I change my mind. What do you do sir?" - John Maynard Keynes

There are no sacred cows at iREIT or Dividend Kings. Wherever the fundamentals lead we always follow. That's the essence of disciplined financial science, the math behind retiring rich and staying rich in retirement.

Bottom Line: 7% Yielding British American Tobacco Is The Perfect Bear Market Buy

This bear market might not be over yet, or we may be near bottom.

No one can know for sure, but when you buy wonderful companies at wonderful prices and hold for the long-term you don't have to pray for luck, you'll make your own.

Today BTI offers one of the safest 7% yields on Wall Street, and remains an Ultra Value strong buy with a PE of 9, even after its impressive rally this year.

BTI's business isn't dying, it's thriving, thanks to strong execution in reduce-risk products.

  • 2X PM's growth rate in fact

BTI has successfully completed de-leveraging and now analysts expect the company to buyback $10 billion worth of stock in just the next three years.

  • 5% annual buyback rate

BTI has become the growth king of tobacco, and it deserves to be a Wall Street darling in 2022 and long beyond.

In fact, the last time BTI was this undervalued, it rocketed higher during the tech crash and kept right on going to 39X returns over 17 years.

I can't promise you 39X returns on BTI in the next 17 years, but I can tell you that this global aristocrat is still a table-pounding good buy.

One that analysts think could deliver Buffett-like 19% annual returns over the next five years, beating the SP 500 by about 4X.

If mouth-watering very safe yield is what you're after, consider BTI.

If incredible value and quality is what you're after, consider BTI.

If a defensive blue-chip bargain that is up 16% during the 2nd worst start to the year in US market history is what you're after, consider BTI.

x

Charlie Bilello

In a market awash in agony, BTI is delivering nothing but net this year.

And with its fundamentals as strong as ever, and a $2.5 billion buyback program underway, BTI represents not just a very safe 7% yield, but one of the best bear market bargains you can buy today.

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