BAT: Camel’s broken back is last straw for investors

British American Tobacco likes to call its primary source of cash combustibles, not cigarettes. On Wednesday, it reminded the market why. A £25bn impairment on its Reynolds American unit, coupled with lower growth estimates, incinerated nearly a tenth of the company’s value.

Companies in long-term, run off sectors such as oil or tobacco face a stark strategic choice. They can extract as much value as possible from legacy assets and liquidate their stock. Or they seek to build new sustainable businesses. BAT has fallen between these two stools.

BAT’s trading update on Wednesday cast its traditional business in poor light. The cost of living squeeze and growth of disposable vapes have induced US smokers to stub out in droves. Industry-wide, cigarette volumes were down 11 per cent in 2022. BAT, which sells premium brands such as Camel, has suffered. Its group sales guidance for this year will only meet the bottom of a 3-5 per cent growth range.

Ordinarily, cigarette makers can offset volume declines by hiking prices, providing mid-single digit operating profit growth. When volumes fall off a cliff, that is much harder. BAT has signalled below-trend growth up to 2026. 

The group has repeated its commitment to a smokeless world. In the rather foggier world of accounting, that means the group no longer values its US brands into perpetuity. By shortening their economic life to 30 years BAT has lopped £25bn off the £67bn attributed to the US brands when it acquired Reynolds American in 2017. The deal, which saw BAT spend $49.4bn to acquire the 57.8 per cent it did not already own, valued the whole business at $100bn including debt. The impairment, which does not affect cash flow, is equivalent to half of BAT’s market value today.

BAT is also doubling down on next generation products, such as vapes. These should break even this year, earlier than expected. Yet this subscale business has marketing spend which eats into profit margins. It does not help that regulators view such products with some degree of suspicion.

BAT will hope that it can grow its way out of this hole, with smokeless products taking off before cigarettes blow out. Judging from its poor shareholder return this year — even including a 10 per cent yield — only a decline in global interest rates will bring investors back to BAT.