Since the turn of the millennium, a bet on British American Tobacco (LSE: BATS) (NYSE: BTI.US) for capital growth has been right.
The cigarette manufacturer’s share price rose from around 300p in year 2000 to 3638p today — that’s capital growth to please the most demanding of investors.
Rising earnings per share
British American Tobacco’s strategy for investors involves driving up earnings-per-share figures by buying back its own shares with its steady and considerable cash flow. Rising earnings per share drive up the share price, in turn.
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The firm’s recent record on earnings-per-share growth looks like this:
|
Year to December |
2009 |
2010 |
2011 |
2012 |
2013 |
|
Adjusted earnings per share |
154p |
177p |
196p |
206p |
217p |
The remarkable record of share-price appreciation that BATS delivered with its buy-back strategy marks the firm out as a model of what can be achieved. The outcome’s not always like this when companies buy back their own shares, and the practice in general attracts a lot of criticism from shareholders.
Buy-backs on hold
With the recent half-year report, BATS revealed that it bought back 19 million more of its own shares during the period, around 1% of the total. However, thanks to the company’s recent investment in Reynolds American, share buy-backs stopped on 30 July. It’s unclear how long the company intends to keep the buy-back programme on hold.
Meanwhile, the half-year results were good with adjusted earnings per share up 8% on the year-ago figure. BATS continues to gain market share in an overall declining industry as well as squeezing inefficiencies from its operations to improve profitability.
BATS, the cash cow
The key to BATS delivering share-holder value is how it uses its steady cash flow to reward investors. So far, the firm has done a good job, by raising the dividend every year and by keeping the share price growing with buy-backs.
The firm’s cash flow and its debt levels are two important indicators to watch. Debt competes with shareholders for cash, and the availability of cash determines how much the firm can spend on the dividend and on buying back its own shares. The recent record looks like this:
|
Year to December |
2009 |
2010 |
2011 |
2012 |
2013 |
|
Net cash from operations (£m) |
3,878 |
4,490 |
4,566 |
4,427 |
4,436 |
|
Net gearing |
117% |
86% |
99% |
116% |
145% |
In the half-time results net cash from operations is down around 11% on the year-ago figure at £1,170 million and net debt climbed by almost 4%, putting the net gearing at about 187%, around 2.4 times the level of last year’s cash flow.
Borrowing is rising and cash flow is flat at best. It will be interesting to see how the whole year works out with the firm’s full-year report due around 26 February. Looking at the figures, though, it’s clear that BATS’ underlying business has been stagnant for some time in terms of its financial performance. The presence of rising debt creates the suspicion that business decline could be around the corner.
What now?
As often happens in declining sectors, the industry seems to be consolidating. BATS’ involvement with Reynolds American suggests that. It remains to be seen whether the firm’s investment in Reynolds American can drive earnings higher.
