British American Tobacco - Falling Cigarette Volumes Do Not Mean Lower Profits

Source from:  Fat Prophets 09/05/2012

The global tobacco industry took note this month of Australia's success in banning cigarette packaging. Whether other countries follow suit remains unclear however tobacco giant British American Tobacco (LON:BATS) is sufficiently geographically diversified to mitigate such issues and maintain profit momentum. Tobacco companies have argued that any such ban would amount to "extinguishing the value of their trade markets without compensation. Naturally investors are concerned that this new law will be rolled out globally and damage profits but the imposed packaging measures may not spread beyond Australia. In the long-term the overall tobacco market is set for growth as growing volumes in the Asia Pacific region offset declining volumes in developed markets. Such growth is driven by rising disposable income in developing countries, which in some cases is seeing the proportion of people smoking increasing. The fundamental nature of the industry is that by selling an addictive product, price increases can be passed through to consumers. Thus even with lower smoking rates in the developed world the tobacco giants generate reliable cash flow for investors. BATS is a globally diversified tobacco group with the Asia Pacific region now the largest profits generator for the company. The group also sees strong profits generation from the geographic division defined as Eastern Europe, Middle East and Africa (EEMA). For BATS, falling cigarette volumes do not mean lower profits. As revenue has grown, margins have improved and stock buy backs have boosted earnings per share. The company's Global Drive Brands - Dunhill, Kent, Lucky Strike and Pall Mall - saw 4% volume growth in the first half of 2012 which compares to 9% in 2011 and 7% in 2010. Asia Pacific volumes were flat while EEMA volumes rose by 2% to help offset a 2% fall in the Americas and 4% in Western Europe. In terms of profits, the strong pricing power saw all regions produce profits growth on a constant currency basis. Thus weak conditions in the Americas and Western Europe didn't stop a 3% and a 2% profits boost respectively, while profits rose by 3% in Asia and 15% in EEMA. Group operating margins continue to improve and - despite negative exchange rate effects - adjusted earnings per share rose by 7% with a 1% boost from stock buybacks. The group's dividend payout was increased by 11%. As sales outside the developed world increase as a proportion of BATS's total sales, the group will have a further cushion against falling volumes in the West. The increasing proportion of Global Drive Brands also shows that the group is successfully increasing the quality of its sales. Enditem