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The Resurgence of the “Buy With Both Hands” Opportunity for British American Tobacco

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I previously highlighted an opportunity for investors in British American Tobacco (BAT) to β€œseize the moment” as positive buying sentiment emerged. BAT experienced a significant bottoming process and started recovering towards its mid-July peak.

However, the recovery was short-lived as selling pressure intensified, leading to a decline back to June levels. This may be attributed to investors anticipating weak performance based on the mid-year update in late July 2023. Disappointing revenue results in the US, influenced by the country’s economic slowdown, may have normalized the premium trend.

Despite BAT underperforming compared to its industry peers in the first half, the company maintained a strong position by strengthening its market leadership in the non-combustible market through products like Vuse. Non-combustible revenue accounted for 16.6% of BAT’s total revenue, an increase from the previous year’s 14.8%.

BAT remains confident in the growth potential of its new product category and aims to achieve Β£5 billion in revenue by 2025. However, investors should focus on BAT’s margin profile as it transitions away from combustible products. The market is assessing whether BAT’s new product growth can lead to significant margin improvement despite the expected decline in combustible volume.

Based on revised analysts’ estimates, BAT’s adjusted EBIT margin may have already reached its low point in the first half of the current fiscal year, signaling potential improvement. Although the margin declined from 46.8% in H2’22 to 44.8% in the first half, it remains higher than the previous year’s low of 42.7%.

Looking ahead to FY25, BAT is expected to continue margin expansion and reach 46.1%. Despite these positive factors, investors need to consider the execution risks associated with BAT’s growth transformation amidst the decline of its legacy categories.

While BTI’s valuation is attractive with a forward EBITDA multiple of 7.1x, below its 10-year average of 11.3x, buying sentiment remains tepid. However, a robust forward dividend yield of 8.9% provides a defense against downside risks as BAT transforms its business.

Investors should be aware of potentially underperforming growth indicated by Seeking Alpha Quant’s β€œD+” growth grade. The market suggests that unless BAT demonstrates a faster growth transformation to counter the decline in legacy categories, it may not see a re-rating from investors despite its favorable valuation.

Nevertheless, the current levels present a high-conviction opportunity for investors to add more shares if they missed the previous June bottom.

BTI experienced a decline towards its June 2023 lows as shown above. However, buyers quickly defended the $31 level vigorously since its October 2022 bottom.

Considering BTI’s attractive valuation, it is unlikely that this defense line will be breached without a strong fight from buyers, especially among income investors seeking attractive yields.

The current double-bottom opportunity may lead to a sustained bullish reversal in BTI’s downward trend. Investors anticipating further upside should closely observe the $34 level. A decisive breakout above that level could attract momentum buyers and support a recovery towards the low $40s range.

Rating: Maintain Buy. Please note that a Buy rating is equivalent to a Bullish or Market Outperform rating.

Important note: Investors should conduct their own due diligence and not solely rely on the provided information as financial advice. Independent thinking is encouraged, and the rating does not imply specific timing for entry or exit points, unless otherwise specified.

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Please note that this article discusses securities that do not trade on a major U.S. exchange, and as such, investors should be aware of the associated risks.

Source: Seekingalpha.com

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