Falling cigarette volumes are hardly a new phenomenon; the tobacco industry has been in steady decline for years. But despite British American Tobacco’s best efforts to put the emphasis of yesterday’s full-year results on the “transformational” acquisition of Reynolds American, the market chose to focus on the decline in organic volumes and sent the shares more than 2 per cent lower.
Although the maker of Dunhill and Lucky Strike reported a 3.2 per cent increase in cigarette volumes, this was driven by the £41.8 billion acquisition of Reynolds in July and on an organic, or underlying, basis its volumes fell by 2.6 per cent. This was better than the wider market decline of about 3.5 per cent, showing that BAT won market share, but the shares still lost 95½p to £43.54½.
Nicandro Durante, the FTSE 100 group’s chief executive, admitted that 2017 provided a “challenging trading environment” but insisted that underlying performance remained robust and investment in so-called next generation products (NGPs) such as vapour and tobacco heating products was beginning to bear fruit.
He said that, together with Reynolds, in which BAT held a 42 per cent stake before last year’s deal, it had invested £1.8 billion in NGPs since 2012 and the combined businesses were “clear leaders in the potentially reduced-risk product space”. “Increased public health awareness, new societal attitudes and rapid developments in new technologies have all combined to create a unique opportunity,” he added.
During the year, BAT reported revenues of £397 million from NGPs, or about £500 million including a full-year contribution from Reynolds. It forecasts that this will double this year to £1 billion and rise to more than £5 billion in 2022. Looking further ahead, BAT wants NGPs to make up 30 per cent of total revenues by 2030 and 50 per cent by 2050.
Impressive though those numbers sound, NGPs remain — and will remain for some time — a small part of the group. Philip Morris, BAT’s rival, has boldly declared that it is heading for a smoke-free future but Ben Stevens, BAT’s finance director, remarked yesterday that this was “aspirational — in the same way that I aspire to run the 100 metres in 10 seconds”.
In other words, it ain’t gonna happen, which is probably the more realistic view. With the benefit of the Reynolds business, total group revenues in 2017 grew by 37.6 per cent to £20.3 billion, or by 2.9 per cent to £15.2 billion on an underlying basis at constant currency. Underlying profits grew by 3.7 per cent to £5.68 billion at constant currency amid improving margins.
The company also backed up its strong record on dividends by rewarding shareholders with a 15.2 per cent increase in the dividend for the year to 195.2p, payable in four quarterly instalments of 48.8p. The Reynolds deal is already delivering on the forecast $400 million of cost savings, achieving a better than expected $70 million last year in areas such as procurement, operations, corporate functions and research and development.
Reynolds also added 36 billion cigarettes to its sales volumes, lifting BAT’s total volumes to 686 billion. Organic volumes grew in Bangladesh, Nigeria, the Gulf and Turkey but this was more than offset by declines in Ukraine, Brazil, South Africa and Russia, driven by excise increases and growth in illicit trade.
There are two other potential threats to BAT shares. The Serious Fraud Office is investigating allegations that it bribed African officials for commercial advantage, while in Canada the group is awaiting judgment on its appeal against a ruling by a Quebec court that it should pay about £5.9 billion to settle two class actions brought by smokers 20 years ago.
ADVICE Hold
WHY Integrating Reynolds American will help BAT offset impact of falling volumes and support a generous dividend
Hays
Like a well-rounded job applicant, Hays also appears to be nicely balanced. The white-collar recruiter, the UK’s biggest by market capitalisation, posted half-year results yesterday in line with the City’s forecasts, prompting a bit of profit taking from investors.
Pre-tax profits rose 18 per cent to £113.9 million in the six months to the end of December and net fees rose 12 per cent to £525.8 million on a like-for-like basis.
Hays has benefited from diversifying its business internationally and across sectors, helping it to absorb the impact of a slowdown in the British market, which accounts for just under a quarter of net fees — compared with 2005 when the international business made up a quarter of net fees. The company has about 10,800 employees based across 256 offices in 33 countries, with a particular focus on accountancy and finance, construction and property and IT.
In a subdued British market Hays has been cutting costs, including consultants, which helped to increase operating profit in the UK by 24 per cent to £22.6 million. Management expects the UK to remain downbeat as Brexit negotiations continue but is confident it has “right-sized” the business and the private sector, a bigger market for Hays, remains more positive than the public.
Meanwhile, 20 of its international markets delivered record growth in net fees during the period, with strong performances in mainland Europe, including Germany, its biggest market where it has been investing heavily, Australia and Asia.
Hays has also been investing in technology, striking partnerships with the likes of Linkedin and Google, to help consultants source potential candidates more efficiently.
It means Hays remains confident of doubling its operating profits by 2022, a target announced at its capital markets day in November.
The balance sheet is also healthy, with net cash of £34.5 million at the end of the period after a £61.6 million special dividend for the year to the end of last June. The interim dividend was raised 10 per cent to 1.06p and UBS, Hays’s joint broker, forecast that about 10 per cent of its market capitalisation could be returned in 20 months.
ADVICE Hold
WHY Shares near record highs but Hays is well diversified