Hedge Fund Managers Run Away From British American Tobacco

Despite holdings reductions, the stock is up in the past 3 months

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Jul 18, 2017
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British American Tobacco PLCÂ (BTI, Financial) sells tobacco products in about 180 countries, of which it holds a leadership position in several. Dunhill, Kent, Pall Mall, Lucky Strike and Rothmans account for a significant portion of its sales.

In the first quarter of the year, several hedge fund managers had bearish sentiments toward the stock. John Rogers (Trades, Portfolio) and John Burbank (Trades, Portfolio) sold out. Jim Simons (Trades, Portfolio), Ken Fisher (Trades, Portfolio), Tom Russo (Trades, Portfolio), Charles Brandes (Trades, Portfolio), Jeff Auxier (Trades, Portfolio), Sarah Ketterer (Trades, Portfolio) and Jeremy Grantham (Trades, Portfolio) have reduced their holdings.

Let´s take a look at the price evolution since then:

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From March 31 to June 7, the stock moved from $66.32 to $73.28, a 10.5% upward movement. Since then, the stock declined to its actual price of $67.98, or a 2.5% appreciation.

The company has two principal drivers. First, an intangible asset is known as the brand portfolio. Secondly, the cost advantage toward its competitors. Both contribute to charge a mark up for their products.

Further, the company competes in an industry that is shifting quickly with the new era of e-cigarettes. Now, a customer has less loyalty to a particular brand and instead is more aware of health issues. Gaining market share is now a principal issue for tobacco companies. The company continues focusing on product innovation and cost reduction because consumers can easily switch to cheaper brands.

British American generates operating margins of more than 30%. Its operating margin is ranked higher than 75% of the 40 companies in the global tobacco industry.

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Earnings have increased from $2.93 to an estimated $3.35 over the past five quarters, showing an acceleration in growth rates.

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Relative valuation

Regarding valuation, the stock sells at a trailing price-earnings (P/E) ratio of 20.85 times, trading at a premium compared to an average of 19.5 times for the industry. It is also close to a 10-year high of 23.4 times. To use another metric, its price-book (P/B) ratio of 12.43 times indicates a premium versus the industry average of 4.1 times. The price-sales (P/S) ratio of 6.9 times is above the industry average of 2.97 times and is close to a 10-year high of 7.1 times.

Final comments

The company operates in a highly regulated industry, with anti-smoking regulations, taxation and high barriers to entry as the main risks. The business is relatively stable, but experts are saying younger generations are less dependent on this habit. According to the Centers for Disease Control and Prevention, the number of middle and high school students consuming tobacco products declined from 4.7 million in 2015 to  3.9 million this year.

Moreover, regulation plays a crucial role and has impacted profits. New products are regulated, which is important because the company recently bought Reynolds American (RAI, Financial) in a $49 billion deal.

Disclosure:Â The author holds no position in any stocks mentioned.