BRITISH AMERICAN TOBACCO

BATS: Look to the E Vapour……

• BATS has underperformed the consumer staples sector and its tobacco peers over the past year due to adverse currency and EM concerns. However during this period they have continued to deliver robust profit, raise dividends & maintain buybacks. The currency and EM d/g’s are now in the price
• Trades at a discount to peer IMT with a P/E of 15.5 vs IMT’s of 24.9, despite delivering superior EPS performance over the past 2 years (chart below/attached). It has also maintained it FY14 buyback, paying shareholders $42.8bn in total cash over the past 4 years through buybacks & dividends (only bested by Philip Morris)

• BATS has a higher exposure to EMs compared to IMT (56% of sales vs 45%). BATS FY2013 report showed that despite falling DM volumes, they still continue with strong revenue (+4%) showing the strength of their pricing power
• E-cigarettes will be and is a major disruptive force. We are negative on the tobacco sector and believe the e cigarette is a game changer
• The transition will not be smooth but ultimately the big boys will transition to e cigarettes. BATs excels its peers already with Vype
• We believe 2014 will be a big year for e-cigarettes both in terms of sales & positioning from the big players.  E-cigarette sales are expected to reach $5bn in 2015, up 233% vs 2013 (BBG)
• BATS was the first international business to enter the e-cigarette market with Vype. This is already an established player in the space and is now sold in over 10,000 stores internationally. They are also establishing a pipeline of next-gen products currently awaiting regulatory approval. Approval will be a major catalyst for BATs outperformance
• BATs currently own 42% of RAI in the US. There is speculation that they will buy the rest of the company. This we feel is a good move and will help in two ways. Firstly it will give them far greater exposure to the US tobacco mkt. Also and more interestingly for us is RAIs intellectual technology and strength in e-cigarettes technology which will benefit BATS through the use of it RAI’s superior Vuse product
• Buy  BATS vs IMT.  The spread between the 2 has widened out over the past year but lost momentum in 2014 bouncing off the 1.3 level several times (graphs below). We really believe BATS outperformance will be driven by its superior positioning in the rapidly expanding e-cigarettes market . Before long all you will see is its Vapour