Consumer Staples British American Tobacco ADR (NYSE: April 11, … · 2019-04-19 · The United...

Important disclosures appear on the last page of this report.

Krause Fund Research Spring 2019 Consumer Staples Recommendation: BUY Analysts Justin Zeimet [email protected] Alexander Egan [email protected]

Company Overview British American Tobacco is a holding company which engages in manufacturing and Global distribution of tobacco products. Its products include Cigarettes, Tobacco heating, Vapor, Tobacco-free nicotine pouches, and Traditional oral moist snuff and snus. Its brands include, Kent, Dunhill, Lucky Strike, Pall Mall, and Rothmans, Camel, Newport, Vype, Glo, Grizzly, and more. The company was founded September of 1902 and is headquartered in London. Stock Performance Highlights 52 Week High $59.55 52 Week Low $30.67 Beta Value 0.742 Average Daily Volume 4.04 m Share Highlights Market Capitalization $85.28 b Shares Outstanding 2.29 b Book Value per share $36.34 EPS (2018) $3.53 P/E Ratio 11.38 Dividend Yield 6.51% Dividend Payout Ratio 76.87% Company Performance Highlights ROA 4.31% ROE 9.54% EBIT Margin 39.96% Net Income Margin 24.64% Sales $32.7 b Financial Ratios Current Ratio 0.81 Debt to Equity 0.72

British American Tobacco ADR (NYSE: BTI) April 11, 2019 Current Price $40.35 Target Price $45-$55 BTI Exhibits Potential Strength

Our team of analyst is issuing a Buy rating on British American Tobacco’s ADR (BTI). We determined this after considering upside potential and downside risk. We believe BTIs 6.5% dividend yield and stable earnings power will provide stabile income to a portfolio with some capital appreciation. Drivers of Thesis We believe BTI will be able to offset decreased Global cigarette demand with gains in market share and pricing power of brands in the strategic portfolio. We believe the present value of future dividend is of the best value in the industry. BTI has a large and diverse brand portfolio with strong brand loyalty to ensure continued revenue streams into the future. Risks of Thesis Regulation is a big risk to BTI, particularly in respect to bans on menthols, which they are a leader in. We believe they overpaid for their recent acquisition on Reynold an that the pending menthol bans will cause large impairments. Rising interest rates would diminish the value of their dividend and potentially impact their ability to service debt One Year Stock Performance

Source (Yahoo Finance)

mailto:[email protected]


Our team of analyst is issuing a Buy rating on British American Tobacco’s ADR (BTI) with a target price between $45-$55. We determined this after considering upside potential and downside risk. We believe BTIs 6.5% dividend yield and stable earnings power will provide stabile income to a portfolio with some capital appreciation, we think this outweighs the risks associated with potential litigation risk, uncertainty in future regulation, and the competition in the vapor and heated tobacco segments.

Real GDP Growth Real GDP growth is one of the truest measurements of the health of the economy, measuring an inflation adjusted real expansion or contraction. The recovery from the great recession has been slow and the new consensus for normal growth is 2-2.5%. However, the last two years, growth has picked up, with three quarters of 3% or higher, including 4.2% during Q2 of 2018, and a 2.73% average over that time (bea 2019). We do not however see this trend continuing. The market is nearing the peak of the cycle and globally business is seeing a slowdown. We believe 2019 GDP will be constricted slightly, coming in at a mild 1.8-2.2%. Consumer staples and even more so the tobacco industry, are very stable and not as hindered by cyclicality in the market, but this could cause adverse conditions for growing their new reduced risk products in the vapor and heated tobacco segments. Because these new products are more expensive and marketed to a less addicted demographic, GDP contraction may cause future revenue growth to be less than expected.

Inflation/ Interest Rates Inflation is important to consider especially in consumer staples, because forwarding the cost increases to consumers can stifle demand but is necessary due to the low margin business model. Additionally, inflation has adverse effects on heavy fixed asset businesses. This is because the diminishing value of cash demands more cash for capital expenditures. Luckily, the tobacco industry requires very few fixed assets to operate (BTIs Net PP&E is 3.5% of total assets). However, inflation can have indirect effects on BTI. If it grows much over the Federal Reserve target of a little more than 2% they may be forced to raise interest rates (Hunnicutt 2019). Raising interest rates can slow consumer spending and hurt earnings, will raise the cost of debt and increase interest expense, and will raise the cost of equity and rate at which future cash flows should be discounted, heavily reducing the price. In the sensitivity analysis section, you can view the drastic changes in intrinsic value accompanied by changing interest rates. CPI/PPI The last two years the CPI growth has been 2.1% and 2.4% respectively, and we agree with the IMF and USDA estimate for 2019 CPI growth of 2.1%(US Inflation 2019). This would probably mean no Fed rate hike and a stabilizing market over the year. However, if economic growth advances throughout the summer the already tight labor market could drive CPI growth to 2.5-2.7% forcing more rate hikes and lower valuations. Below we attached a comparison of the CPI and PPI to show the spread in input cost compared to selling prices. This spread is important because most consumer staples companies, BTI included, need to maintain margins to maximize value and benefit from slow growth in input costs while gradually increasing selling prices to consumers. This and generic label products have weighed on margins in past years

Executive Summary

Economic Analysis


Data source: (Bureau of Labor Statistics)

reducing the value of many highly brand reliant companies.

Unemployment The United States is in an unprecedented job market, with job openings exceeding people actively seeking out work. This caused unemployment to drop to an all-time low of 3.7% (bls 2019). Now as more people have rejoined the workforce, the rate has risen to 3.8% and appears to be poised to stay there for the near future. If the job market remains this robust throughout 2019 and into 2020 wages will likely rise potentially driving inflation and interest rates higher straining margins for consumer staples.

Geopolitical The various trade wars the current administration is in has caused a slowing global economy. Goods have become more expensive and many emerging economies have been hurt. With BTI being a global company, the global unrest will have some adverse effects on earnings. Tobacco prices have not yet been affected, so the issue has been with slowing global economies more than rising input costs.

Additionally, a huge consideration in valuing any tobacco company should be regulation. In 2020 the European Union will be implementing a menthol ban. This is a significant headwind because BTIs biggest strength is menthol cigarettes. A similar regulation has been considered by the FDA also. Banning menthols in the United States would cause diminished earnings while BTI attempts to rebrand themselves to secure the existing menthol users for other products. Another recent regulation that has passed is limiting the amount of nicotine in cigarettes to a non-addictive level. For obvious reason having a product that is no longer addictive will cause demand to decrease and revenues to fall. In the coming years regulations will come into effect restricting vapors and heated tobacco products. We feel BTI is in a position to absorb regulation and continue to deliver solid earnings for a foreseeable future.

Description: The tobacco industry is sub-sect of the Consumer Stables sector of the market and is comprised of companies that grow, prepare, ship, and distribute tobacco related products. These products include smokable tobacco, smokeless tobacco, and vapor combustibles. The industry itself is largely comprised of six international companies, Imperial Brands (IMB-GB), Japan Tobacco (2914-JP), Phillip Morris International (PM), Vector Group (DDD), Swedish Match (EEE), and British American Tobacco (BTI).

IMB-GB11%

2914-JP15%

PM42%DDD

0%

EEE3%

BTI29%

Market Cap Tobacco Industry

Industry Analysis

Data source: (Bureau of Labor Statistics)

Source: (ThompsonOne)


Industry Trends Technology The largest development in new technology for the tobacco industry has been the growth of Vapor and Heated Tobacco Products (HTPs). Consumer preferences are shifting toward smoking devices that create less smoke, smell, and are generally less detrimental to one’s health. Growth in these segments has far outpaced any other. HTPs and Vapors have seen a 529% and 21.8% 3-yr CAGR respectively in retail volume vs a (2.4%) for traditional cigarettes between 2014-2017 (Smokefreeworld 2018). British American Tobacco has recognized this trend and has shifted much of its growth perspective into these product segments. BTI has been aggressively pursuing market share in the HTP segment primarily through their “Glo” line in Japan, the country that accounts for 70% of global volume in the segment. Glo has reached 20% market share in Japan and has produced revenue growth of 188% over the past year. BTI plans to continue its growth in Japan and expand HTP market share in South Korea, Romania, and Italy (BATS 20F). As for the Vapors segment, BTI’s growth and market share have been less impressive. The company’s primary market for this segment is in the US where they market their VUSE, ALTO, and VIBE lines. Over the past year, they have seen 28% revenue growth, but market share has lagged due to the dominance of JUUL in the US market. Outside of JUUL, BTI controls double the market share of any of its direct competitors which indicates it could be in a position to grow their presence if JUUL begins to give any ground.

Source: (ThompsonOne) Demographic

Globally speaking, smoking rates have been on the decline for the past two decades. According to WHO, smoking rates have decreased globally about 7% globally from 2000 to 2015 and this trend is expected to continue into the future with a further 3% decline expected to be realized by 2025. Declining smoking rates are a threat to the whole industry and the hope for sustainability has shifted to the only growing product segments: Vapor, HTP, and Oral tobacco. When smoking rates are broken down by global regions we begin to see where opportunities are most promising for growth.

Source: WHO Demographically speaking, the regions with the most forward looking potential are in the Western Pacific where smoking rates are expected to decrease about 2% slower between 2020-2025 than the global average and in the Eastern Mediterranean where rates are expected to increase by a little over 1% in the same time frame. Out of the top competitors in these two regions PM and IMB have historically held the largest market shares. Recently, JP and BTI have been creating space for themselves for the future.

Source: Passport

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Aggregate Cigarette Market Shares

Philip MorrisInternational Inc

British AmericanTobacco Plc

Japan TobaccoInc

Imperial BrandsPlc


Porter’s Five Forces Analysis Threat of New Entrance: Moderate The industry overall is difficult to enter due to the difficulty of competing with the few multinational corporations that control much of the industry. These companies are working with economies of scale that can be difficult to replicate and given the low margin nature of the business this alone provides a large barrier to entry. That being said, JUUL has shown recently that new product segments like vapor are more exposed relative to traditional cigarettes. Successes like JUUL should be hard to recreate given they had a large first mover advantage in the segment and were able to take advantage of holes in advertising and product regulation that have since been filled. Bargaining Power of Suppliers: Low The bargaining power of tobacco farmers has drastically diminished since 2000. Traditionally, tobacco was sold at government-sanctioned auctions which used a quota system to keep supply managed and prices high. In 2004 that changed, and the process moved to the free market. The result was plummeting prices and much of the bargaining power moving to Cigarette companies (Forbes 2015). Today, most tobacco is sourced directly from farmers that have fixed deals with these Cigarette companies. In exchange, Cigarette companies provide field support, new technologies, and capacity building for their farmers. Bargaining Power of Buyers: Low The low bargaining power of buyers is low mostly due to the addictive nature of the products sold in the industry. Most smokers will pay what they must for their product, and it can be seen in the inelastic demand of tobacco products. In addition, the heavy consolidation of the industry does not allow buyers many options to switch to. Threat of Substitutes: Moderate The substitutes that threaten the tobacco industry are those products that are typically used to quit cigarettes. These include nicotine patches, gum, and lozenges. With public attitudes shifting away from cigarettes, as can be seen in the demographics section, these substitutes threaten to decrease smoking dependency even further.

Ironically, new technologies like Vapes can also be viewed as substitutes and have been shown to be more effective than traditional nicotine replacements in getting consumers to quit cigarettes. In a study published in the New England Journal of Medicine, subjects who used Vapes to abstain from cigarettes were twice as likely to be successful compared to traditional nicotine replacements. It is worth noting, however, that out of those subjects that used Vapes to quit, 80% continued to use their Vaper product (Medpagetoday 2019). This suggests that companies that prioritize this segment have a mitigated risk of substitutes. Competitive Rivalry: Large Due to the highly consolidated nature of the industry, the major companies we have identified all compete heavily for market share and volume sales. When comparing the investment opportunity of BTI relative to others in the industry we decided to focus on a few key metrics. Dividend Yield: A major reason for our investment interest in BTI was the large dividend that they have consistently paid year over year. When comparing BTI’s current dividend yield, however, we found that their dividend yield of 6.57% is comparable to their peer average of 6.26%. While they do lead most of their peers, they lag behind IMB’s 7.49%. (ThompsonOne 2019) Net Profit Margin: A primary metric of a firm’s overall performance and ability to consistently maintain dividend payments is its net profit margin. Currently BTI exceeds its peer average, 24.64% vs 18.12%. We are concerned that BTI may not be able to consistently maintain this margin due to our projected impairment of goodwill and intangibles in 2022 and 2023 due to bans on menthol cigarettes in the EU and US. (ThompsonOne 2019) Growth Position: The tobacco industry is in its maturity and therefore traditional tobacco products should not expect very much growth. For that reason, the primary growth driver for the industry going forward will be volume and market share in Vapor and HTP products. As of 2017 BTI is in second place out of its competitors, but at a significant lag of PM. We expect current metrics to be more in BTIs favor due to


a significant amount of their NGP launches occurred during 2017.

Source: Passport

Business Description British American Tobacco p.l.c. provides cigarettes and other tobacco products worldwide. It manufactures vapor and tobacco heating products; oral tobacco and nicotine products, such as snus and moist snuff; cigars; and e-cigarettes. The company offers its products under the Dunhill, Kent, Lucky Strike, Pall Mall, Rothmans, Newport, Camel, Native American Spirit, Vogue, Viceroy, Kool, Peter Stuyvesant, Craven A, Benson & Hedges, John Player Gold Leaf, State Express 555, Shuang Xi, Glo, Vype, Vuse, Epok, Kodiak, Mocca, and Grizzly brands. The company sells its products to retail outlets. British American Tobacco p.l.c. was founded in 1902 and is headquartered in London, the United Kingdom.

Source: 20-F Corporate Strategy

Growth: BTI’s current focusing measure for growth is growth in volume and market share. They have been pursuing their growth strategy primarily through their Strategic Portfolio Brands (SPBs) (Dunhill, Kent, Lucky Strike, Pall Mall, Rothmans, Newport, Camel, Native American Spirit) and their Next-Generation Products (NGP) (Glo, Vype, Vuse, Epok). BTI historically has pushed for expanded market share for its Strategic Portfolio for their respective key markets. Those markets are largely comprised of countries that fall in the regions that we have identified as the best at maintaining smoking rates (Eastern Europe and Western Pacific).Specifically, Dunhill, Kent, Lucky Strike, Pall Mall, and Rothmans are targeted internationally and over the past 3 years their market share in these key markets has grown 1.3%. BTI’s focus on the correct markets for their international SPBs is the primary reason that our model forecasts an average growth of 2% each year of the forecast vs -5% growth for non-strategic brands. The other half of BTI’s growth strategy revolves around their Next-Generation Products. With the growing popularity that can be seen in vaper and HTP segments BTI has made it a priority to gain market share in both segments. In pursuit of this BTI has launched a variety of variety of vapor lines in some of the world’s largest vapor markets. They have launched Vuse and VIP in the US, VIP and Ten Motive in the UK, Vype in Canada, the UK, and the EU, and Chic internationally.

Source: Bloomberg As for HTPs, BTI has been successful in accumulating 20% market share in Japan which as a country represents 70% of the global HTP market.

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Global Vapor Market Share

Philip MorrisInternational Inc

British AmericanTobacco Plc

Japan TobaccoInc

JUUL Labs Inc

Combustile Tobacco -Strategic Portfolio, 63.10%

Oral Tobacco,

3.70%

Vapor, 1.30%

Tobacco Heating

Products, 2.30%

Combustile Tobacco -

Other Brands, 29.54%

Revenue Decomposition

US, 43%

UK, 13%

China, 6%Italy, 7%

Malaysia, 6%

Other, 25%

Worlds Largest Vapor Markets 2016

Company Analysis


Products & Markets BTI has a large and international portfolio of products. These products are separated into 2 segments, Cigarettes and Potentially Reduced Risk Products, the latter further being broken down into Heated not Smoked Tobacco (HTP), Vapors, and Snus & Moist Oral Tobacco. HTP and Vapors also form the subset of next-gen products (NGP). Brand Performance: Dunhill: Industry market share was stable after falling last year and volume has continued to fall, reporting in 6.1% lower than last year. Dunhill’s primary markets in Brazil and South Africa are facing market size reduction and growth in Indonesia has not been able to offset this. It is our expectation that Dunhill as a brand should continue to decline due to illicit trade in its markets being a large reason for market size reduction and brand volume being cannibalized by other brands held by BTI. Kent: Market share was up 50 bps, with volume increasing 1.7% after having similar growth last year. This was primarily driven by Kent’s HTP sticks for the Glo experiencing strong growth in Japan and Kent cigarette sales in Ukraine and Turkey. Kent’s growth is expected to continue due to being positioned in strong smoking rate regions and the success of the Glo. Lucky Strike: Market share grew 20 bps but volumes fell 1%. This is due to industry contraction in France, but Lucky Strike has been a historically strong brand for the company, and we see no reason this should not continue. Pall Mall: Market share grew 10 bps, with volume up 20.4%. This strong volume growth was largely due to the brands recent inclusion to the US after the RAI acquisition in 2017. The rate of volume growth is expected to decrease, but the overall performance of the brand is expected to remain strong due to its success within the Middle East. Rothmans: Market share grew, increasing 110 bps with volume up 19.7%. This seems to be driven by increased demand in the right target regions, specifically Eastern Europe.

Newport: Market share grew 10 bps in the US and volume declined 4.6%. This seems to be driven by the growth of vapor in the US. It is our expectation that this trend will continue as consumer preferences in the US continue to shift toward Vaper and a possible ban on menthols by the FDA. No timetable is given for this legislation, but BTI has commented that they are working with lawmakers to create sensible legislation. Camel: Market share was flat in the US and volume was lower by 4.4%. Camel is facing the same Vaper threat that Newport is in the US and therefore is expected to slowly lose volume. Natural American Spirit: Market share grew in the US, up 20 bps, and volume grew higher by 3.5%. This is the one US based brand that we are expecting to see continued growth. The premium status of this brand makes it more attractive in the continued strong US economy that we are forecasting. (All brand performance metrics retrieved from BATS 20-F) Cigarette sales are overall on a decline in Western markets and especially in the U.S. BTI has been able to offset volume declines on many of its lines by expanding to the right markets including Ukraine, Indonesia, Turkey, and Japan. For this reason, we are expecting a steady decay in growth for SPBs aside from 2020 when an EU ban on menthol cigarettes takes effect.

PRRP Performance: NGPs: BTI saw a 35% increase in volume sales this year in their global vapor portfolio and 127% growth

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Revenue Growth (SPBs)


in volume in their HTP portfolio. Notably, BTI missed their guidance estimate for revenue of NGPs by about $100 million. BTI is maintaining their 2025 guidance for this segment of about $6.5B, but we have modeled our assumptions $2B lower due to pessimism surrounding the growth of HTPs. We still are forecasting strong growth in the category, but we are more conservative due to the fact BTI is already commanding a large market share in Japan leaving little room for growth. Japan as a nation accounts for 70% of the global market so if BTI wants to achieve higher growth they will have to find ways to grow HTP demand in other markets. Oral: BTIs oral portfolio grew in revenue 11% this year benefiting from strong growth of their EPOK brand in Scandinavia and receiving resistance from a decrease in revenue from Grizzly, their primary oral product in the US. Our estimates see both these trends continue as new oral products like EPOK develop market share in their markets and US tobacco consumption continues to decline. Production & Distribution BTI does not own any tobacco farms so they source 400,000 tonnes of tobacco per year for 90.000 contracted farmers to which they provide support and advice to ensure a consistent product.(20-F) They have also recently completed a Global Supply Chain Service Center in the U.K that serves as headquarters for its worldwide distribution system. Raw materials for production have been steady in price to the benefit of BTI. Their suppliers have little to no pricing power since most are small farmers and there isn’t a tobacco shortage in any of their production areas. This can be seen in the strong gross margin numbers seen in the financial summary. S.W.O.T Strengths Portfolio Diversity: BTIs biggest strength is their large and diverse portfolio of brands that have significant market shares. In the following chart you can see that in a survey done by Statista five of the top 15 responses for “What kind of cigarettes do you smoke” are owned by BTI.

Source: Statista Margin Maintenance: BTI has historically been able to maintain or reduce their gross margin YOY. The one exception recently being in 2017 when they were in the process of integrating RAI after its acquisition. Gross margin reduction has been achieved primarily through keeping COGS low through direct sourcing of their tobacco leaf and owning all of their production for their cigarettes. Looking forward this trend should continue due to the recent opening of their Global Supply Chain Service Center and their company friendly contract revision with their PRRP suppliers.

Source: Factset Weaknesses: Highly levered: The acquisition of RAI left BTI highly levered compared to its peers. Currently, their net debt/EBITA FY1 is significantly higher than the peer average, 4.0 vs 2.79 (ThompsonOne 2019). They have been using commercial paper to maintain liquidity, but with half of their total debt maturing in the next five years if interest rates rise, they could face significant costs to borrow or refinance. (BATS 20-F)

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Gross Margin


Opportunities: Acquisitions: A recent string of acquisitions has opened a variety of opportunities that BTI can capitalize on. The largest has been the companies purchase of RAI for $49.4B (20-F). With this acquisition BTI has expanded its oral and cigarette market in the US with the Newport, Native American Spirit, Camel, Pall Mall, and Grizzly. They also inherited a large amount of market share in the US vapor market via VUSE and expanded into Russia and Turkey with RAI’s Kent and Pall Mall brands (GlobalData 2019). New Product Launches: In 2018 we were able to see the results of some of BTIs new product launches. In 2017 BTI launched their Glo HTP product in Romania and Russia. While we are not provided with exact numbers BTI maintains that these launches were successful and contributed to the 20bps market share growth in Europe (20-F). As the market grows for these products BTI must ensure they are properly positioned in key markets if they want to sustain growth through decreasing cigarette volume. Threats: Industry Competition: The consolidated nature of the tobacco industry leads to intense rivalry amongst the key competitors. BTI competes with not only the key competitors already outlined in the report, but also state-run enterprises in China, Thailand, and Egypt amongst others. The result is reduced prices for producers which pushes on margins. If BTI wants to maintain growth they must ensure to maintain customer loyalty and grow market share, especially in the growing NGP space. Falling Smoking Rates: The growing health consciousness amongst consumers is reflected in the falling cigarette sales across the industry. We view this trend as creating a stigma against traditional tobacco rather than a total departure from health risking products in general. This is can be seen in the growing sales of Vapor and HTPs. The key to future success will be to prolong volume sales as long as possible while building NGP market share for the future. Valuation Analysis:

Revenue Decomposition: At the heart of any valuation model is revenue. We forecast BTIs revenues to be steadfast over the forecast horizon, with growth never exceeding 3.53% and only decreasing in 2020 (-0.83%.) When deconstructing BTIs revenue we accepted the continued weakness of the non-strategic combustible segment, forecasting revenues to fall 5% per year. However, we are confident in the strength on heated tobacco and vapors over the coming decade. We believe vapors and heated tobacco will displace cigarettes in a moderate number of existing smokers looking for safer alternatives and will dominate in the acquisition of new customers. As stated earlier, Juul currently dominates the US vapor market. We do not think this kind of dominate market share can persist and think BTI is poised to attract some existing users into their Vuse brand e-cigarette driving segment growth by 24% a year over the next 5 years before tapering to the mid to high single digits in 2026 and beyond. Additionally, BTI has bet heavily on heated tobacco products (HTPs). HTPs produce the most similar to smoking experience with potentially reduced risk and we believe will be a top choice for existing smokers. Using company expectations, we forecast a 75% growth in this segment next year before quickly leveling out to more sustainable rates. Finally, is the strategic portfolio, this is the primary revenue source for BTI. We believe this segment will see slight growth except for 2020 when the EU menthol ban will adversely affect revenue. Long term we see gains in market share and pricing offsetting decreased global smoking volume to maintain flat earnings.

Valuation Analysis


Margins: We believe margins will be mostly maintained throughout our forecast but not improved. We forecast that gross margin will never exceed last year’s number of 58.57% or fall below 57.75%. This is because of the stability in the tobacco market, along with the ability to easily transfer costs to the consumer. Additionally, we believe the EBIT margin will remain most steady, declining from 39.96% to 35.48% over the next 12 years. This decline is attributed to rising SG&A expense connected to the focus on vapors and HTPs. Impairments: We forecast an impairment to goodwill and intangible assets in 2020 and 2023 because of the menthol ban coming to the EU in 2020 and potentially the US in 2023. In 2017 BTI finalized an acquisition of Reynolds tobacco. Reynolds was known for their strength in the menthol market and BTI accumulated 144 billion of intangible asset and goodwill because of that strength. However, the banning will decrease the value of these brands, even if they are able to maintain their strength without the menthol flavors. Because of this we estimate $3.2 billion in impairments in 2020 and $4 billion in 2023. This is obviously a significant development that needs to be considered, but it has minimal effect on our DCF valuing model. Dividends: BTI is a significant dividend producer, paying a dividend yield of nearly 6.5%. Therefor, it is important to include that we predict the dividend will be cut from $2.71 to $2.50 during 2020 due to the menthol ban. We believe this dividend will stay constant through 2023 before adjusting to a 65% payout as BTI repositions themselves in the market to handle the new regulations. Debt Reduction:

BTIs management shared in the annual 20-f filing their commitment to deleveraging from the Reynold acquisition. Because of this, we believe excess cash will go mostly to paying off debt. We expect debt to be reduced from $57 billion to $41 billion in 2030. WACC: We calculated WACC using CAPM. We believe the 10 year US treasury yield is the best option for the risk free rate and it currently yields 2.48%. For an equity risk premium, we have decided it would be best to used Damodaran’s estimated number, currently equaling 5.75%. Finally, we used Bloomberg to calculate 4 year weekly beta, which equals .742. Plugging these values into the CAPM formula, we find the required return on equity is 6.75%. for figuring the cost of debt we used the current estimated YTM on a 30 year bond issued by BTI resulting in 4.23%. Next, we determine the proportional amounts of market value of equity and debt. This is used for the weighting to the two required returns. Since BTI is committed to paying down debt we used a variable WACC sheet that starts with debt making up 40% of the capital and ends with debt only representing 31%. Because of this the WACC advances from 5.27% in 2018 to 5.59% in 2030. Discounted Cash Flow & Economic Profit Valuations: When calculating the intrinsic value of BTI, we use discounted cash flow (DCF) and economic profit (EP) models that use financial statement forecasts to estimate net operating profit less all taxes (NOPLAT) and the invested capital (IC) in the company. By dividing this year’s NOPLAT by last year’s IC we can find the return on invested capital (ROIC). This makes a big impact when estimating continuing value of operations. Additional figures we found were, free cash flow (FCF) which is the NOPLAT minus the change in IC and economic profit (EP) which is calculated by multiplying the invested capital by the spread that the ROIC has on the WACC. We used the DCF as out main valuation model. In the DCF valuation model we discounted the forecasted future FCFs by an implied constant WACC except for the continuing value year. This is because we found that the implied forward WACC was a better representation of future discounting than the WACCs


leading up to that. After discounting and finding the value of operations we added all non-operating assets and subtracted all debt and minority interest. Finally, we divided by the shares outstanding to find the per share intrinsic value of $50.51 The EP model was similar as it too discounts the future EPs. However, because of how economic profit is calculated to had to use the implied constant WACC instead of the future WACC. This gave us a slightly different price of $50.49. Dividend Discount Model: In the dividend discount model (DDM), we discount all forecasted dividends and the calculated to future price using an expected EPS and P/E ratio. The expected P/E ratio was calculated using the following assumptions, long term EPS growth of 0.09%, return of equity of 8.12%, and a cost of equity of 6.75%, resulting in a future P/E ratio of 14.86. Then, by multiply the expected P/E ratio by the estimated 2030 EPS of $4.02 we find the expected future price of $59.66. After discounting we found the present value of these to be $48.34 per share. Relative Valuation: We additionally did a relative valuation model comparing BTI to their competitors using P/E ratio for the expected EPS. The comparison companies were, Imperial Brands, Japan Tobacco, Philip Morris, Vector Group, and Swedish Match (We decided against Altria Holding because they have a much more diversified portfolio of holdings). After comparing BTIs price to 2019’s expected earning we found BTI to be undervalued, but when comparing it to 2020’s expected earnings we found BTI to be fairly valued. However, due to the large differences in earnings growth, locational strengths, and balance sheet strength, we do not find this to be the most accurate of valuation methods. Sensitivity Analysis: Beta & Risk Free Rate: Beta and the risk free rate are significant drivers of stock price. We included this in the sensitivity analysis because we remain at historically low interest rates which have propped up asset values and we wanted to show how even small rate changes could alter stock price. If the risk free rate would increase from the current level of 2.48% to even 4% BTI intrinsic value would decrease from $50.51 to $38.88. Additionally,

if BTIs relative risk to the market were to change raising the beta to 1.0 the value would be slashed to $39.13. Continuing NOPLAT Growth: We estimated continuing NOPLAT growth to be -1.33%, if management beats out expectations and are able to maintain a steady NOPLAT in the continuing value year the estimated value would see a slight increase to $54.11, but if they under perform and NOPLAT shrinks by 2% the value will drop to $49.18. Strategic Portfolio Growth: The strategic portfolio is key to the success of BTI. If they can successfully increase revenue in this segment by even 1.5% a year that value would jump to $56.86, but if they underperform by 1.5% the value would fall to $44.94. COGS & SG&A: COGS and SG&A have a direct impact on margins are a significant driver in consumer staples. However, BTI, like many other tobacco companies have large margin decreasing sensitivity in COGS and SG&A. Weakening input cost lowering COGS as a percent of sales by 1.5% though would increase the value by almost $3 a share and the same for if inputs would rise. A similar result happens when SG&A changes, a 1.5% decrease would increase value by $2.75, and the same increase would have a similar effect. Other Combustibles Growth: BTIs portfolio of other combustibles is currently providing $9.5 billion in revenue, but these are dying product lines, being milked for any last dollar they can provide. We currently forecast this segment to decline by 5% per year. If this decline slows to a 1% decline the intrinsic value would increase to $55.79, but if the decay strengthens with revenue falling by 11% per year that value of the company would fall to $45.62. Marginal Tax Rate: Taxes are a drain on company value and even small changes in the marginal rate can have very large impacts. According to our analysis 5% change in the marginal rate would have a 10% impact on the value of BTI. Cost of Equity & Debt: The cost of equity and debt have significant impacts on the value of a company because of the discounting affect. If BTIs cost of debt were to increase to even 5%,


we expect the value to decrease to $48.48. Change in the cost of equity has an even greater impact, an 1.25% change either way would vary the price from $42-$66.

This report was created by students enrolled in the Applied Equity Valuation class at the University of Iowa. The report was originally created to offer an internal investment recommendation for the University of Iowa Krause Fund and its advisory board. The report also provides potential employers and other interested parties an example of the students’ skills, knowledge and abilities. Members of the Krause Fund are not registered investment advisors, brokers or officially licensed financial professionals. The investment advice contained in this report does not represent an offer or solicitation to buy or sell any of the securities mentioned. Unless otherwise noted, facts and figures included in this report are from publicly available sources. This report is not a complete compilation of data, and its accuracy is not guaranteed. From time to time, the University of Iowa, its faculty, staff, students, or the Krause Fund may hold a financial interest in the companies mentioned in this report

Important Disclosure


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British American TobaccoRevenue Decomposition

Fiscal Years Ending Dec. 31 2016 2017 2018 2019E 2020E 2021E 2022E 2023E 2024E 2025E 2026E 2027E 2028E 2029E CV (2030E)Revenue 20,095.1 32,064.1 32,698.8 33,853.4 33,568.0 34,145.1 34,753.8 35,425.0 36,096.5 36,995.2 37,846.7 38,691.6 39,203.0 39,453.9 39,453.6Revenue Growth 0.15% 59.56% 1.98% 3.53% -0.84% 1.72% 1.78% 1.93% 1.90% 2.49% 2.30% 2.23% 1.32% 0.64% 0.00% Tobacco Product Manufacturing 20,095.1 32,064.10 32,698.80 33,853.38 33,568.00 34,145.09 34,753.79 35,424.97 36,096.55 36,995.25 37,846.67 38,691.61 39,203.03 39,453.86 39,453.60 Stretegic Portfolio — 21,533.70 23,039.50 24,677.05 24,850.48 25,863.45 26,886.23 27,950.78 28,996.07 30,249.80 31,438.49 32,603.84 33,419.65 33,959.65 34,234.10 Combustile Tobacco - Strategic Portfolio — 19,837.90 20,636.30 21,668.12 21,234.75 21,659.45 22,092.64 22,534.49 22,985.18 23,674.73 24,384.98 25,116.53 25,618.86 25,875.05 25,875.05 Potentially Reduced Risk — 1,695.80 2,403.10 3,008.93 3,615.73 4,204.00 4,793.59 5,416.29 6,010.89 6,575.06 7,053.51 7,487.32 7,800.80 8,084.61 8,359.06 Oral Tobacco — 1,101.70 1,224.30 1,346.73 1,481.40 1,629.54 1,792.50 1,935.90 2,090.77 2,195.31 2,261.17 2,329.00 2,398.87 2,446.85 2,495.79 Next Generation Products — 594.00 1,178.90 1,662.20 2,134.32 2,574.46 3,001.09 3,480.40 3,920.12 4,379.76 4,792.35 5,158.32 5,401.92 5,637.76 5,863.27 Vapour — 332.50 424.60 530.75 663.44 809.39 971.27 1,146.10 1,352.40 1,555.26 1,741.89 1,863.82 1,975.65 2,074.44 2,157.41 Tobacco Heating Products — 261.60 754.30 1,131.45 1,470.89 1,765.06 2,029.82 2,334.29 2,567.72 2,824.50 3,050.46 3,294.49 3,426.27 3,563.32 3,705.86 Combustile Tobacco - Other Brands — 9,673.50 9,659.30 9,176.34 8,717.52 8,281.64 7,867.56 7,474.18 7,100.47 6,745.45 6,408.18 6,087.77 5,783.38 5,494.21 5,219.50 Other Businesses — 856.9 0% of Revenue By Segment Combustile Tobacco - Strategic Portfolio 61.90% 63.10% 64.01% 63.26% 63.43% 63.57% 63.61% 63.68% 63.99% 64.43% 64.91% 65.35% 65.58% 65.58% Oral Tobacco 3.40% 3.70% 3.98% 4.41% 4.77% 5.16% 5.46% 5.79% 5.93% 5.97% 6.02% 6.12% 6.20% 6.33% Vapour 1% 1.30% 1.57% 1.98% 2.37% 2.79% 3.24% 3.75% 4.20% 4.60% 4.82% 5.04% 5.26% 5.47% Tobacco Heating Products 0.80% 2.30% 3.34% 4.38% 5.17% 5.84% 6.59% 7.11% 7.63% 8.06% 8.51% 8.74% 9.03% 9.39% Combustile Tobacco - Other Brands 30.20% 29.54% 27.11% 25.97% 24.25% 22.64% 21.10% 19.67% 18.23% 16.93% 15.73% 14.75% 13.93% 13.23%Growth by Segment Combustile Tobacco - Strategic Portfolio 4.02% 5.00% ‐2.00% 2.00% 2.00% 2.00% 2.00% 3.00% 3.00% 3.00% 2.00% 1.00% 0.00% Oral Tobacco 11.13% 10.00% 10.00% 10.00% 10.00% 8.00% 8.00% 5.00% 3.00% 3.00% 3.00% 2.00% 2.00% Vapour 27.70% 25.00% 25.00% 22.00% 20.00% 18.00% 18.00% 15.00% 12.00% 7.00% 6.00% 5.00% 4.00% Tobacco Heating Products 188.34% 50.00% 30.00% 20.00% 15.00% 15.00% 10.00% 10.00% 8.00% 8.00% 4.00% 4.00% 4.00% Combustile Tobacco - Other Brands ‐8.27% ‐5.00% ‐5.00% ‐5.00% ‐5.00% ‐5.00% ‐5.00% ‐5.00% ‐5.00% ‐5.00% ‐5.00% ‐5.00% ‐5.00%

British American TobaccoBalance Sheet

Fiscal Years Ending Dec. 31 2016 2017 2018 2019E 2020E 2021E 2022E 2023E 2024 2025 2026 2027 2028 2029 CV (2030E)AssetsCash 2,723.37 4,451.90 3,312.50 3,316.43 4,059.59 4,198.96 4,195.36 4,171.88 6,032.15 7,052.82 9,525.58 12,280.60 15,070.78 17,877.39 20,675.52 Total Short Term Investments 481.90 396.36 451.90 473.95 537.09 614.61 625.57 637.65 649.74 665.91 681.24 696.45 705.65 710.17 710.16 Accounts Receivables, Net 3,331.31 4,472.19 4,407.70 4,570.21 4,531.68 4,780.31 4,865.53 4,959.50 5,053.52 5,271.82 5,393.15 5,513.55 5,586.43 5,622.18 5,622.14 Other Receivables 1,553.21 1,632.77 905.88 1,015.60 1,007.04 1,195.08 1,390.15 1,417.00 1,624.34 1,664.79 1,892.33 1,934.58 1,960.15 1,972.69 1,972.68 Inventories 7,158.12 7,932.53 7,684.00 7,891.22 7,824.70 8,707.00 8,210.58 8,369.15 8,527.81 8,740.13 8,941.28 9,140.89 9,261.72 9,320.98 9,320.91 Other Current Assets 170.52 336.84 118.76 338.53 335.68 290.23 295.41 301.11 306.82 314.46 321.70 328.88 333.23 335.36 335.36 Total Current Assets 15,418.44 19,222.58 16,880.74 17,605.94 18,295.77 19,786.19 19,582.60 19,856.28 22,194.38 23,709.93 26,755.28 29,894.96 32,917.96 35,838.76 38,636.77 Net Property, Plant & Equipment 4,523.72 6,604.13 6,584.60 7,307.83 7,993.21 8,673.75 9,306.45 9,895.17 10,443.45 10,954.57 11,431.54 11,877.12 12,293.84 12,684.07 13,049.95 Total Investments and Advances 12,336.91 3,388.23 2,988.23 2,988.23 2,988.23 2,988.23 2,988.23 2,988.23 2,988.23 2,988.23 2,988.23 2,988.23 2,988.23 2,988.23 2,988.23 Long-Term Note Receivable 740.15 1,022.68 1,124.96 1,164.56 1,007.04 682.90 695.08 708.50 721.93 739.90 756.93 773.83 784.06 789.08 789.07 Goodwill 13,620.57 59,719.85 59,704.40 59,704.40 58,704.40 58,704.40 58,704.40 55,704.40 55,704.40 55,704.40 55,704.40 55,704.40 55,704.40 55,704.40 55,704.40 Other Intangible Assets 1,351.80 99,613.81 98,362.60 97,378.97 95,305.18 94,352.13 93,408.61 91,474.52 90,559.78 89,654.18 88,757.64 87,870.06 86,991.36 86,121.45 85,260.23 Deferred Tax Assets 538.20 428.70 438.50 438.50 438.50 438.50 438.50 438.50 438.50 438.50 438.50 438.50 438.50 438.50 438.50 Deferred Charges 562.22 739.14 806.70 846.33 839.20 853.63 695.08 708.50 631.69 554.93 567.70 580.37 588.05 591.81 591.80 Total Assets 49,092.01 190,739.11 186,890.72 187,434.76 185,571.53 186,479.73 185,818.94 181,774.09 183,682.36 184,744.65 187,400.22 190,127.47 192,706.40 195,156.29 197,458.96 Liabilities & Shareholders' EquityST Debt & Curr. Portion LT Debt 3,432.64 6,733.99 5,385.20 5,715.80 5,409.75 5,611.40 4,923.92 4,705.32 4,525.42 4,663.99 4,824.31 4,932.02 4,997.21 5,029.18 5,029.15 Accounts Payable 1,582.87 3,108.62 3,350.00 3,156.49 2,973.39 3,047.45 2,627.39 2,510.74 2,558.34 2,622.04 2,682.38 2,742.27 2,778.51 2,796.29 2,796.27 Income Tax Payable 1,149.16 1,473.15 1,498.00 1,562.09 1,223.87 1,540.64 1,554.59 984.07 1,608.68 1,670.31 1,676.71 1,725.83 1,756.37 1,772.33 1,774.21 Other Current Liabilities 8,944.87 10,210.56 10,490.30 10,833.08 10,741.76 10,926.43 11,121.21 11,335.99 11,550.89 11,838.48 12,110.93 12,381.32 12,544.97 12,625.24 12,625.15 Total Current Liabilities 15,109.53 21,526.31 20,723.50 21,267.46 20,348.77 21,125.92 20,227.10 19,536.13 20,243.34 20,794.82 21,294.34 21,781.43 22,077.06 22,223.04 22,224.78 Long-Term Debt 20,353.63 59,541.29 55,169.80 53,496.08 51,855.48 50,008.06 48,208.54 45,336.99 43,601.75 41,063.85 40,161.23 39,256.97 38,349.23 37,439.62 36,529.10 Capital Lease Obligations 19.77 16.23 18.00 18.00 18.00 18.00 18.00 18.00 18.00 18.00 18.00 18.00 18.00 18.00 18.00 Provision for Risks & Charges 1,497.61 2,942.23 2,627.95 2,627.95 2,627.95 2,627.95 2,627.95 2,627.95 2,627.95 2,627.95 2,627.95 2,627.95 2,627.95 2,627.95 2,627.95 Deferred Tax Liabilities 345.98 22,672.09 22,657.53 22,657.53 22,657.53 22,657.53 22,657.53 22,657.53 22,657.53 22,657.53 22,657.53 22,657.53 22,657.53 22,657.53 22,657.53 Other Liabilities 1,432.12 1,538.08 1,604.94 1,354.14 1,342.72 1,024.35 695.08 708.50 721.93 739.90 756.93 773.83 784.06 789.08 789.07 Total Liabilities 38,758.63 108,236.23 102,801.72 101,421.16 98,850.45 97,461.81 94,434.19 90,885.10 89,870.50 87,902.06 87,515.99 87,115.71 86,513.83 85,755.22 84,846.44 Common Equity 727.80 948.28 910.17 910.17 910.17 910.17 910.17 910.17 910.17 910.17 910.17 910.17 910.17 910.17 910.17 Common Stock Par/Carry Value 626.48 830.59 830.59 Additional Paid-In Capital/Capital Surplus 101.32 117.69 117.69 Retained Earnings 15,587.73 92,787.83 95,097.30 97,021.90 97,729.37 100,026.22 102,393.04 101,897.30 104,820.15 107,850.89 110,892.52 114,020.06 117,200.87 120,409.37 123,620.82 ESOP Debt Guarantee - - - - - - - - - - - - - - - Cumulative Translation Adjustment (472.02) (5,504.29) (5,516.96) (4,568.68) (4,568.68) (4,568.68) (4,568.68) (4,568.68) (4,568.68) (4,568.68) (4,568.68) (4,568.68) (4,568.68) (4,568.68) (4,568.68) Unrealized Gain/Loss Marketable Securities 48.03 22.23 - - - - - - - - - - - - - Revaluation Reserves 221.18 221.31 - - - - - - - - - - - - - Other Appropriated Reserves 129.43 (41.94) - - - - - - - - - - - - - Unappropriated Reserves 110.01 473.03 - - - - - - - - - - - - Treasury Stock (6,469.79) (7,051.54) (7,027.54) (7,027.54) (7,027.54) (7,027.54) (7,027.54) (7,027.54) (7,027.54) (7,027.54) (7,027.54) (7,027.54) (7,027.54) (7,027.54) (7,027.54) Total Shareholders' Equity 10,610.16 82,803.19 84,411.25 86,335.85 87,043.32 89,340.17 91,706.99 91,211.25 94,134.10 97,164.84 100,206.47 103,334.01 106,514.82 109,723.32 112,934.77 Accumulated Minority Interest 276.79 300.31 322.25 322.25 322.25 322.25 322.25 322.25 322.25 322.25 322.25 322.25 322.25 322.25 322.25 Total Equity 10,333.38 82,502.88 84,089.00 86,013.60 86,721.07 89,017.92 91,384.74 90,889.00 93,811.85 96,842.59 99,884.22 103,011.76 106,192.57 109,401.07 112,612.52 Total Liabilities & Shareholders' Equity 49,092.01 190,739.11 186,890.72 187,434.76 185,571.53 186,479.73 185,818.94 181,774.09 183,682.36 184,744.65 187,400.21 190,127.47 192,706.40 195,156.29 197,458.96

British American TobaccoIncome Statement

Fiscal Years Ending Dec. 31 2016 2017 2018 2019E 2020E 2021E 2022E 2023E 2024 2025 2026 2027 2028 2029 CV (2030E)Sales 20,095 26,066 32,698.80 33,853.38 33,568.00 34,145.09 34,753.79 35,424.97 36,096.55 36,995.25 37,846.67 38,691.61 39,203.03 39,453.86 39,453.60 COGS 7,779 9,648 12,168.00 12,525.75 12,420.16 12,804.41 13,032.67 13,284.36 13,536.20 13,873.22 14,192.50 14,509.35 14,701.14 14,795.20 14,795.10 Depreciation 501 501 522.00 526.77 584.63 639.46 693.90 744.52 791.61 835.48 876.37 914.52 950.17 983.51 1,014.73 Amortization of Intangibles 232 551 858.00 983.63 973.79 953.05 943.52 934.09 914.75 905.60 896.54 887.58 878.70 869.91 861.21 Gross Income 11,584 15,365 19,150.80 19,817.24 19,589.42 19,748.17 20,083.70 20,462.00 20,853.98 21,380.96 21,881.26 22,380.16 22,673.03 22,805.24 22,782.56 SG&A 4,420 6,249 6,220.00 6,439.63 6,545.76 6,658.29 6,950.76 7,439.24 7,580.27 7,769.00 8,326.27 8,512.15 8,624.67 8,679.85 8,679.79 Research & Development 72 103 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 Other Operating Expense -229 -86 -34.30 - - - - - - 1.00 2.00 3.00 4.00 5.00 6.00 EBIT (Operating Income) 7,321 9,100 13,065.10 13,277.61 12,943.66 12,989.88 13,032.94 12,922.76 13,173.71 13,510.95 13,452.99 13,765.00 13,944.36 14,020.39 13,996.77 Nonoperating Interest Income 92 108 90.80 94.61 98.31 92.65 77.85 79.24 80.77 96.02 98.41 100.67 102.92 104.28 104.95 Reserves Increase (Decrease) 0 0 - - - - - - - 1.00 2.00 3.00 4.00 5.00 6.00 Other Income (Expense) -544 -28Interest Expense 911 1,409 2,144.00 2,561.48 2,504.66 2,422.32 2,352.70 2,247.50 2,116.79 2,035.78 1,934.29 1,902.89 1,869.19 1,833.55 1,796.43 Goodwill Impairment 0 0 - - 1,000.00 - - 3,000.00 - - - - - - - Other Intangibles Impairment 0 0 110.00 - 1,100.00 - - 1,000.00 - - - - - - - Property, Plant & Equipment Impairment 0 0 36.86 - - - - - - - - - - - - Restructuring Expense 814 970 484.00 - - - - - - 1.00 2.00 3.00 4.00 5.00 6.00 Legal Claim Expense 27 88 - - - - - - - - - - - - - Hedges/Derivatives 440 218 211.00 151.28 151.28 151.28 151.28 151.28 151.28 151.28 151.28 151.28 151.28 151.28 151.28 Other Unusual Expense 136 -29,991 -42.70 - - - - - - 1.00 2.00 3.00 4.00 5.00 6.00 Pretax Income 5,421 36,922 10,634.74 10,962.03 8,588.59 10,811.49 10,909.37 6,905.78 11,288.97 11,721.48 11,766.40 12,111.07 12,325.37 12,437.40 12,450.57 Income Taxes 1,897 -10,448 2,858 3,124.18 2,447.75 3,081.28 3,109.17 1,968.15 3,217.36 3,340.62 3,353.42 3,451.66 3,512.73 3,544.66 3,548.41 Equity in Earnings of Affiliates 3,005 1,186 517.00 517.00 517.00 517.00 517.00 517.00 517.00 517.00 517.00 517.00 517.00 517.00 517.00 Consolidated Net Income 6,529 48,556 8,293.74 8,354.85 6,657.85 8,247.22 8,317.20 5,454.63 8,588.61 8,897.86 8,929.97 9,176.42 9,329.64 9,409.74 9,419.16 Minority Interest 258 220 237.60 237.60 237.60 237.60 237.60 237.60 237.60 238.60 239.60 240.60 241.60 242.60 243.60 Net Income 6,272 48,336 8,056.14 8,117.25 6,420.25 8,009.62 8,079.60 5,217.03 8,351.01 8,659.26 8,690.37 8,935.82 9,088.04 9,167.14 9,175.56 EPS 3.37 23.65 3.53 3.55 2.81 3.51 3.54 2.28 3.65 3.79 3.80 3.91 3.98 4.01 4.02 Total Shares Outstanding 1,858.37 2,044.00 2,285.11 2,285.11 2,285.11 2,285.11 2,285.11 2,285.11 2,285.11 2,285.11 2,285.11 2,285.11 2,285.11 2,285.11 2,285.11 Dividends per Share 2.30 2.52 2.71 2.71 2.50 2.50 2.50 2.50 2.38 2.46 2.47 2.54 2.59 2.61 2.61 Dividend Payout 68.15% 10.66% 76.87% 76.29% 88.98% 71.32% 70.71% 109.50% 65.00% 65.00% 65.00% 65.00% 65.00% 65.00% 65.00%

British American TobaccoCash Flow Statement

Fiscal Years Ending Dec. 31 2016 2017 2018Operating Activities

Net Income / Starting Line 6,272 48,336 8,056Depreciation, Depletion & Amortization 733 1,052 1,380Other Funds -1,377 -43,711 1720Changes in Working Capital -167 -92 578Net Operating Cash Flow 5,461 5,585 11,734

Investing ActivitiesCapital Expenditures -909 -1,259 -1208.2Net Assets from Acquisitions -94 -22,838 -42.7Sale of Fixed Assets & Businesses 135 122 -204Purchase/Sale of Investments -119 -13 23Other Funds 31 0 0Net Investing Cash Flow -957 -23,988 -1,432

Financing ActivitiesCash Dividends Paid -3,944 -4,462 -5803Change in Capital Stock -86 -264 -185.6Issuance/Reduction of Debt, Net -491 25,913 -4652.8Other Funds -338 -730 -133.5Net Financing Cash Flow -4,860 20,457 -10,775

Exchange Rate Effect 242.9 -503.5 -184.2

Net Change in Cash -330.92 2078.32 -447.66

British American TobaccoCash Flow Statement

Fiscal Years Ending Dec. 31 2019E 2020E 2021E 2022E 2023E 2024E 2025E 2026E 2027E 2028E 2029E CV (2030E)Operating ActivitiesNet Income / Starting Line 8,117.25 6,420.25 8,009.62 8,079.60 5,217.03 8,351.01 8,659.26 8,690.37 8,935.82 9,088.04 9,167.14 9,175.56 Depre/ Amort 1,510.39 1,558.42 1,592.51 1,637.42 1,678.60 1,706.36 1,741.07 1,772.91 1,802.10 1,828.87 1,853.42 1,875.94 Impairments - 2,100.00 - - 4,000.00 - - - - - - - Change in A/R 272.23 (47.09) 436.67 280.29 120.81 301.37 258.75 348.87 162.65 98.45 48.28 (0.05) Change in Inv 207.22 (66.52) 882.30 (496.42) 158.57 158.66 212.32 201.15 199.62 120.82 59.26 (0.06) Change In Other Assets 219.77 (2.85) (45.45) 5.17 5.71 5.71 7.64 7.24 7.18 4.35 2.13 (0.00) Change in A/P (193.51) (183.10) 74.06 (420.06) (116.64) 47.60 63.70 60.34 59.89 36.25 17.78 (0.02) Change in Income Tax Payable 64.09 (338.21) 316.76 13.95 (570.51) 624.60 61.63 6.40 49.12 30.54 15.97 1.88 Change in Other Current Liabilities 342.78 (91.32) 184.67 194.78 214.78 214.91 287.58 272.45 270.38 163.65 80.27 (0.08) Change in Deferred Charges 39.63 (7.13) 14.43 (158.55) 13.42 (76.81) (76.76) 12.77 12.67 7.67 3.76 (0.00) Change in Provision for Risks & Charges - - - - - - - - - - - - Change in Other Long Term Liabilities (250.80) (11.42) (318.37) (329.28) 13.42 13.43 17.97 17.03 16.90 10.23 5.02 (0.01) Net Operating Cash Flow 8,851.34 9,578.21 8,571.31 9,545.91 10,138.17 10,568.99 10,429.27 10,249.48 10,752.07 10,926.29 11,026.15 11,053.38

Investing ActivitiesCapital Expenditures (1,250.00) (1,270.00) (1,320.00) (1,326.60) (1,333.23) (1,339.90) (1,346.60) (1,353.33) (1,360.10) (1,366.90) (1,373.73) (1,380.60) Change in Total Long Term Investments - - - - - - - - - - - - Investment in Long-Term Note Receivable (39.60) 157.52 324.14 (12.17) (13.42) (13.43) (17.97) (17.03) (16.90) (10.23) (5.02) 0.01 Change in Total Short Term Investments (22.05) (63.14) (77.52) (10.96) (12.08) (12.09) (16.18) (15.33) (15.21) (9.21) (4.51) 0.00 Net Investing Cash Flow (1,311.64) (1,175.62) (1,073.39) (1,349.73) (1,358.74) (1,365.42) (1,380.75) (1,385.69) (1,392.21) (1,386.33) (1,383.26) (1,380.59)

Financing ActivitiesIssuance/Reduction of Debt, Net (1,343.12) (1,946.65) (1,645.77) (2,487.01) (3,090.15) (1,915.13) (2,399.33) (742.29) (796.56) (842.55) (877.63) (910.55) Dividends Paid (6,192.65) (5,712.78) (5,712.78) (5,712.78) (5,712.78) (5,428.16) (5,628.52) (5,648.74) (5,808.28) (5,907.23) (5,958.64) (5,964.11) Stock Repurchases 0 0 0 0 0 0 0 0 0 0 0 0Net Financing Cash Flow (7,535.76) (7,659.42) (7,358.55) (8,199.79) (8,802.92) (7,343.29) (8,027.85) (6,391.04) (6,604.85) (6,749.77) (6,836.28) (6,874.66)

Net Change in Cash 3.93 743.16 139.37 (3.60) (23.48) 1,860.28 1,020.67 2,472.76 2,755.02 2,790.18 2,806.61 2,798.13

British American TobaccoCommon Size Balance Sheet

Fiscal Years Ending Dec. 31 2016 2017 2018 2019E 2020E 2021E 2022E 2023E 2024E 2025E 2026E 2027E 2028E 2029E CV(2030E)AssetsCash 13.55% 17.08% 10.13% 9.80% 12.09% 12.30% 12.07% 11.78% 16.71% 19.06% 25.17% 31.74% 38.44% 45.31% 52.40%Total Short Term Investments 2.40% 1.52% 1.38% 1.40% 1.60% 1.80% 1.80% 1.80% 1.80% 1.80% 1.80% 1.80% 1.80% 1.80% 1.80%Accounts Receivables, Net 16.58% 17.16% 13.48% 13.50% 13.50% 14.00% 14.00% 14.00% 14.00% 14.25% 14.25% 14.25% 14.25% 14.25% 14.25%Other Receivables 7.73% 6.26% 2.77% 3.00% 3.00% 3.50% 4.00% 4.00% 4.50% 4.50% 5.00% 5.00% 5.00% 5.00% 5.00%Inventories 35.62% 30.43% 23.50% 23.31% 23.31% 25.50% 23.63% 23.63% 23.63% 23.63% 23.63% 23.63% 23.63% 23.63% 23.63%Other Current Assets 0.85% 1.29% 0.36% 1.00% 1.00% 0.85% 0.85% 0.85% 0.85% 0.85% 0.85% 0.85% 0.85% 0.85% 0.85%Total Current Assets 76.73% 73.75% 51.62% 52.01% 54.50% 57.95% 56.35% 56.05% 61.49% 64.09% 70.69% 77.26% 83.97% 90.84% 97.93%Net Property, Plant & Equipment 22.51% 25.34% 20.14% 21.59% 23.81% 25.40% 26.78% 27.93% 28.93% 29.61% 30.20% 30.70% 31.36% 32.15% 33.08%Total Investments and Advances 61.39% 13.00% 9.14% 8.83% 8.90% 8.75% 8.60% 8.44% 8.28% 8.08% 7.90% 7.72% 7.62% 7.57% 7.57%Long-Term Note Receivable 3.68% 3.92% 3.44% 3.44% 3.00% 2.00% 2.00% 2.00% 2.00% 2.00% 2.00% 2.00% 2.00% 2.00% 2.00%Goodwill 67.78% 229.11% 182.59% 176.36% 174.88% 171.93% 168.92% 157.25% 154.32% 150.57% 147.18% 143.97% 142.09% 141.19% 141.19%Other Intangible Assets 6.73% 382.17% 300.81% 287.65% 283.92% 276.33% 268.77% 258.22% 250.88% 242.34% 234.52% 227.10% 221.90% 218.28% 216.10%Deferred Tax Assets 2.68% 1.64% 1.34% 1.30% 1.31% 1.28% 1.26% 1.24% 1.21% 1.19% 1.16% 1.13% 1.12% 1.11% 1.11%Deferred Charges 2.80% 2.84% 2.47% 2.50% 2.50% 2.50% 2.00% 2.00% 1.75% 1.50% 1.50% 1.50% 1.50% 1.50% 1.50%Total Assets 244.30% 731.77% 571.55% 553.67% 552.82% 546.14% 534.67% 513.12% 508.86% 499.37% 495.16% 491.39% 491.56% 494.64% 500.48%Liabilities & Shareholders' EquityST Debt & Curr. Portion LT Debt 17.08% 25.83% 16.47% 16.88% 16.12% 16.43% 14.17% 13.28% 12.54% 12.61% 12.75% 12.75% 12.75% 12.75% 12.75%Accounts Payable 7.88% 11.93% 10.25% 9.32% 8.86% 8.93% 7.56% 7.09% 7.09% 7.09% 7.09% 7.09% 7.09% 7.09% 7.09%Income Tax Payable 5.72% 5.65% 4.58% 4.61% 3.65% 4.51% 4.47% 2.78% 4.46% 4.51% 4.43% 4.46% 4.48% 4.49% 4.50%Other Current Liabilities 44.51% 39.17% 32.08% 32.00% 32.00% 32.00% 32.00% 32.00% 32.00% 32.00% 32.00% 32.00% 32.00% 32.00% 32.00%Total Current Liabilities 75.19% 82.59% 63.38% 62.82% 60.62% 61.87% 58.20% 55.15% 56.08% 56.21% 56.26% 56.29% 56.31% 56.33% 56.33%Long-Term Debt 101.29% 228.43% 168.72% 158.02% 154.48% 146.46% 138.71% 127.98% 120.79% 111.00% 106.12% 101.46% 97.82% 94.89% 92.59%Capital Lease Obligations 0.10% 0.06% 0.06% 0.05% 0.05% 0.05% 0.05% 0.05% 0.05% 0.05% 0.05% 0.05% 0.05% 0.05% 0.05%Provision for Risks & Charges 7.45% 11.29% 8.04% 7.76% 7.83% 7.70% 7.56% 7.42% 7.28% 7.10% 6.94% 6.79% 6.70% 6.66% 6.66%Deferred Tax Liabilities 1.72% 86.98% 69.29% 66.93% 67.50% 66.36% 65.19% 63.96% 62.77% 61.24% 59.87% 58.56% 57.80% 57.43% 57.43%Other Liabilities 7.13% 5.90% 4.91% 4.00% 4.00% 3.00% 2.00% 2.00% 2.00% 2.00% 2.00% 2.00% 2.00% 2.00% 2.00%Total Liabilities 192.88% 415.25% 314.39% 299.59% 294.48% 285.43% 271.72% 256.56% 248.97% 237.60% 231.24% 225.15% 220.68% 217.36% 215.05%Common Equity 3.62% 3.64% 2.78% 2.69% 2.71% 2.67% 2.62% 2.57% 2.52% 2.46% 2.40% 2.35% 2.32% 2.31% 2.31%Common Stock Par/Carry Value 3.12% 3.19% 2.54% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%Additional Paid-In Capital/Capital Surplus 0.50% 0.45% 0.36% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%Retained Earnings 77.57% 355.98% 290.83% 289.40% 293.96% 295.72% 297.35% 290.32% 293.02% 294.09% 295.51% 297.14% 301.38% 307.59% 315.74%ESOP Debt Guarantee 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%Cumulative Translation Adjustment ‐2.35% ‐21.12% ‐16.87% ‐16.30% ‐16.44% ‐16.16% ‐15.87% ‐15.57% ‐15.28% ‐14.91% ‐14.58% ‐14.26% ‐14.07% ‐13.98% ‐13.98%Unrealized Gain/Loss Marketable Securities 0.24% 0.09% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%Revaluation Reserves 1.10% 0.85% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%Other Appropriated Reserves 0.64% ‐0.16% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%Unappropriated Reserves 0.55% 1.81% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%Treasury Stock ‐32.20% ‐27.05% ‐21.49% ‐20.76% ‐20.94% ‐20.58% ‐20.22% ‐19.84% ‐19.47% ‐19.00% ‐18.57% ‐18.16% ‐17.93% ‐17.81% ‐17.81%Total Shareholders' Equity 52.80% 317.67% 258.15% 255.03% 259.30% 261.65% 263.88% 257.48% 260.78% 262.64% 264.77% 267.07% 271.70% 278.11% 286.25%Accumulated Minority Interest 1.38% 1.15% 0.99% 0.95% 0.96% 0.94% 0.93% 0.91% 0.89% 0.87% 0.85% 0.83% 0.82% 0.82% 0.82%Total Equity 51.42% 316.52% 257.16% 254.08% 258.34% 260.70% 262.95% 256.57% 259.89% 261.77% 263.92% 266.24% 270.88% 277.29% 285.43%Total Liabilities & Shareholders' Equity 244.30% 731.77% 571.55% 553.67% 552.82% 546.14% 534.67% 513.12% 508.86% 499.37% 495.16% 491.39% 491.56% 494.64% 500.48%

British American TobaccoCommon Size Income Statement

Fiscal Years Ending Dec. 31 2016 2017 2018 2019E 2020E 2021E 2022E 2023E 2024E 2025E 2026E 2027E 2028E 2029E CV(2030E)Sales 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%COGS 38.71% 37.02% 37.21% 37.00% 37.00% 37.50% 37.50% 37.50% 37.50% 37.50% 37.50% 37.50% 37.50% 37.50% 37.50%Depreciation 2.49% 1.92% 1.60% 1.56% 1.74% 1.87% 2.00% 2.10% 2.19% 2.26% 2.32% 2.36% 2.42% 2.49% 2.57%Amortization of Intangibles 1.15% 2.11% 2.62% 2.91% 2.90% 2.79% 2.71% 2.64% 2.53% 2.45% 2.37% 2.29% 2.24% 2.20% 2.18%Gross Income 57.64% 58.95% 58.57% 58.54% 58.36% 57.84% 57.79% 57.76% 57.77% 57.79% 57.82% 57.84% 57.83% 57.80% 57.75%SG&A 22.00% 23.97% 19.02% 19.02% 19.50% 19.50% 20.00% 21.00% 21.00% 21.00% 22.00% 22.00% 22.00% 22.00% 22.00%Research & Development 0.36% 0.40% 0.31% 0.30% 0.30% 0.29% 0.29% 0.28% 0.28% 0.27% 0.26% 0.26% 0.26% 0.25% 0.25%Other Operating Expense -1.14% -0.33% -0.10% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.01% 0.01% 0.01% 0.01% 0.02%EBIT (Operating Income) 36.43% 34.91% 39.96% 39.22% 38.56% 38.04% 37.50% 36.48% 36.50% 36.52% 35.55% 35.58% 35.57% 35.54% 35.48%Nonoperating Interest Income 0.46% 0.42% 0.28% 0.28% 0.29% 0.27% 0.22% 0.22% 0.22% 0.26% 0.26% 0.26% 0.26% 0.26% 0.27%Reserves Increase (Decrease) 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.01% 0.01% 0.01% 0.01% 0.02%Other Income (Expense) -2.71% -0.11% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%Interest Expense 4.53% 5.41% 6.56% 7.57% 7.46% 7.09% 6.77% 6.34% 5.86% 5.50% 5.11% 4.92% 4.77% 4.65% 4.55%Goodwill Impairment 0.00% 0.00% 0.00% 0.00% 2.98% 0.00% 0.00% 8.47% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%Other Intangibles Impairment 0.00% 0.00% 0.34% 0.00% 3.28% 0.00% 0.00% 2.82% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%Property, Plant & Equipment Impairment 0.00% 0.00% 0.11% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%Restructuring Expense 4.05% 3.72% 1.48% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.01% 0.01% 0.01% 0.01% 0.02%Legal Claim Expense 0.13% 0.34% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%Hedges/Derivatives 2.19% 0.83% 0.65% 0.45% 0.45% 0.44% 0.44% 0.43% 0.42% 0.41% 0.40% 0.39% 0.39% 0.38% 0.38%Other Unusual Expense 0.68% -115.06% -0.13% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.01% 0.01% 0.01% 0.01% 0.02%Pretax Income 26.98% 141.65% 32.52% 32.38% 25.59% 31.66% 31.39% 19.49% 31.27% 31.68% 31.09% 31.30% 31.44% 31.52% 31.56%Income Taxes 9.44% -40.08% 8.74% 9.23% 7.29% 9.02% 8.95% 5.56% 8.91% 9.03% 8.86% 8.92% 8.96% 8.98% 8.99%Equity in Earnings of Affiliates 14.95% 4.55% 1.58% 1.53% 1.54% 1.51% 1.49% 1.46% 1.43% 1.40% 1.37% 1.34% 1.32% 1.31% 1.31%Consolidated Net Income 32.49% 186.28% 25.36% 24.68% 19.83% 24.15% 23.93% 15.40% 23.79% 24.05% 23.60% 23.72% 23.80% 23.85% 23.87%Minority Interest 1.28% 0.84% 0.73% 0.70% 0.71% 0.70% 0.68% 0.67% 0.66% 0.64% 0.63% 0.62% 0.62% 0.61% 0.62%Net Income 31.21% 185.44% 24.64% 23.98% 19.13% 23.46% 23.25% 14.73% 23.14% 23.41% 22.96% 23.09% 23.18% 23.24% 23.26%

British American TobaccoValue Driver Estimation

Fiscal Years Ending Dec. 31 2016 2017 2018 2019E 2020E 2021E 2022E 2023E 2024E 2025E 2026E 2027E 2028E 2029E CV (2030E)NOPLATSales 20095 26066 32699 33853 33568 34145 34754 35425 36097 36995 37847 38692 39203 39454 39454COGS 7779 9648 12168 12526 12420 12804 13033 13284 13536 13873 14193 14509 14701 14795 14795SG&A 4420 6249 6220 6440 6546 6658 6951 7439 7580 7769 8326 8512 8625 8680 8680Depreciation 501 501 522 527 585 639 694 745 792 835 876 915 950 984 1015Non‐Goodwill Intangibles 232 551 858 984 974 953 944 934 915 906 897 888 879 870 861R&D 72 103 100 100 100 100 100 100 100 100 100 100 100 100 100Other Operating Expenses ‐229 ‐86 ‐34 0 0 0 0 0 0 1 2 3 4 5 6Implied Interest on Operating Leases 38 83 71 71 71 71 71 71 71 71 71 71 71 71 71EBITA 7359 9183 12936 13349 13015 13061 13104 12994 13245 13582 13524 13836 14015 14091 14068

Income Tax Exp 1897 ‐10448 2858 3124 2448 3081 3109 1968 3217 3341 3353 3452 3513 3545 3548Nonoperating Interest Income - 26 31 26 27 28 26 22 23 23 27 28 29 29 30 30Reserves Increase (Decrease) + 0 0 0 0 0 0 0 0 0 0 1 1 1 1 2Other Income (Expense) - -155 -8 0 0 0 0 0 0 0 0 0 0 0 0 0Interest Expense + 260 402 611 730 714 690 671 641 603 580 551 542 533 523 512Impairments + 0 0 42 0 599 0 0 1,140 0 0 0 0 0 0 0Restructuring Expense + 232 276 138 0 0 0 0 0 0 0 1 1 1 1 2Legal Claim Expense + 8 25 0 0 0 0 0 0 0 0 0 0 0 0 0Hedges/Derivatives - 125 62 60 43 43 43 43 43 43 43 43 43 43 43 43Other Unusual Expense + 39 -8,547 -12 0 0 0 0 0 0 0 1 1 1 1 2Adjusted Taxes 2,438.56 (18,377.40) 3,550.65 3,784.12 3,688.94 3,702.12 3,714.39 3,682.99 3,754.51 3,851.19 3,835.24 3,924.74 3,976.42 3,998.66 3,992.50

∆ In Deferred Taxes ‐29 22436 ‐24 0 0 0 0 0 0 0 0 0 0 0 0NOPLAT 4,892.08$ 49,995.81$ 9,361.02$ 9,564.42 9,325.65 9,358.69 9,389.48 9,310.70 9,490.13 9,730.69 9,688.68 9,911.20 10,038.87 10,092.66 10,075.20

Invested CapitalNormal Cash 2,035.70 2,640.53 3,312.50 3,316.43 3,400.55 3,459.01 3,520.68 3,588.67 3,656.70 3,747.74 3,834.00 3,919.59 3,971.40 3,996.81 3,996.78 Receivables 4,884.52 6,104.96 5,313.58 5,585.81 5,538.72 5,975.39 6,255.68 6,376.49 6,677.86 6,936.61 7,285.48 7,448.14 7,546.58 7,594.87 7,594.82 Inventories 7,158.12 7,932.53 7,684.00 7,891.22 7,824.70 8,707.00 8,210.58 8,369.15 8,527.81 8,740.13 8,941.28 9,140.89 9,261.72 9,320.98 9,320.91Other Current Assets 170.52 336.84 118.76 338.53 335.68 290.23 295.41 301.11 306.82 314.46 321.70 328.88 333.23 335.36 335.36Total Current Operating Assets 14,248.87 17,014.85 16,428.84 17,131.99 17,099.65 18,431.64 18,282.35 18,635.42 19,169.19 19,738.94 20,382.45 20,837.50 21,112.93 21,248.01 21,247.87 Accounts Payable 1,582.87 3,108.62 3,350.00 3,156.49 2,973.39 3,047.45 2,627.39 2,510.74 2,558.34 2,622.04 2,682.38 2,742.27 2,778.51 2,796.29 2,796.27Income Tax Payable 1,149.16 1,473.15 1,498.00 1,562.09 1,223.87 1,540.64 1,554.59 984.07 1,608.68 1,670.31 1,676.71 1,725.83 1,756.37 1,772.33 1,774.21Other Current Liabilities 8,944.87 10,210.56 10,490.30 10,833.08 10,741.76 10,926.43 11,121.21 11,335.99 11,550.89 11,838.48 12,110.93 12,381.32 12,544.97 12,625.24 12,625.15Total Operating WC 2,571.98 2,222.53 1,090.54 1,580.33 2,160.63 2,917.12 2,979.16 3,804.62 3,451.28 3,608.11 3,912.42 3,988.09 4,033.08 4,054.15 4,052.24

Net PPE 4,523.72 6,604.13 6,584.60 7,307.83 7,993.21 8,673.75 9,306.45 9,895.17 10,443.45 10,954.57 11,431.54 11,877.12 12,293.84 12,684.07 13,049.95Non‐Goodwill intangibles + 1,351.80 99,613.81 98,362.60 97,378.97 95,305.18 94,352.13 93,408.61 91,474.52 90,559.78 89,654.18 88,757.64 87,870.06 86,991.36 86,121.45 85,260.23deferred Charges + 562.22 739.14 806.70 846.33 839.20 853.63 695.08 708.50 631.69 554.93 567.70 580.37 588.05 591.81 591.80PV Operating Leases + 262 509 507 563 616 668 717 763 805 844 881 915 947 978 1006Capital Leases + 19.77 16.23 18.00 18.00 18.00 18.00 18.00 18.00 18.00 18.00 18.00 18.00 18.00 18.00 18.00Other Liabilities ‐ 1,432.12 1,538.08 1,604.94 1,354.14 1,342.72 1,024.35 695.08 708.50 721.93 739.90 756.93 773.83 784.06 789.08 789.07

Total Invested Capital 7,858.98 108,166.70 105,764.94 106,340.52 105,589.50 106,458.72 106,429.43 105,954.88 105,187.10 104,894.11 104,811.35 104,475.12 104,087.70 103,657.91 103,188.85

NOPLAT 4,892.08$ 49,995.81$ 9,361.02$ 9,564.42$ 9,325.65$ 9,358.69$ 9,389.48$ 9,310.70$ 9,490.13$ 9,730.69$ 9,688.68$ 9,911.20$ 10,038.87$ 10,092.66$ 10,075.20$ Invested Capital 7,858.98 108,166.70 105,764.94 106,340.52 105,589.50 106,458.72 106,429.43 105,954.88 105,187.10 104,894.11 104,811.35 104,475.12 104,087.70 103,657.91 103,188.85 ROIC 61.87% 636.16% 8.65% 9.04% 8.77% 8.86% 8.82% 8.75% 8.96% 9.25% 9.24% 9.46% 9.61% 9.70% 9.72%FCF 4,939.77 (50,311.91) 11,762.78 8,988.84 10,076.67 8,489.47 9,418.77 9,785.25 10,257.92 10,023.68 9,771.44 10,247.42 10,426.29 10,522.45 10,544.25 EP 4,461.46 49,567.78 3,469.90 3,804.11 3,533.99 3,607.94 3,591.39 3,514.20 3,719.48 4,001.85 3,975.80 4,202.82 4,348.80 4,423.70 4,284.08

British American TobaccoWeighted Average Cost of Capital (WACC) Estimation

2018 2019 2020 2021 2022 2023 2024 2025 2026 2028 2029 2030(CV)Risk Free 2.48% 2.48% 2.48% 2.48% 2.48% 2.48% 2.48% 2.48% 2.48% 2.48% 2.48% 2.48%Risk Premium 5.75% 5.75% 5.75% 5.75% 5.75% 5.75% 5.75% 5.75% 5.75% 5.75% 5.75% 5.75%Beta 0.74 0.74 0.74 0.74 0.74 0.74 0.74 0.74 0.74 0.74 0.74 0.74Cost of Equity 6.75% 6.75% 6.75% 6.75% 6.75% 6.75% 6.75% 6.75% 6.75% 6.75% 6.75% 6.75%

Debt Rating BBB+ BBB+ BBB+ BBB+ BBB+ BBB+ BBB+ BBB+ BBB+ BBB+ BBB+ BBB+Default Spread 1.39% 1.39% 1.39% 1.39% 1.39% 1.39% 1.39% 1.39% 1.39% 1.39% 1.39% 1.39%Pre-Tax Cost of Debt 4.23% 4.23% 4.23% 4.23% 4.23% 4.23% 4.23% 4.23% 4.23% 4.23% 4.23% 4.23%Tax Rate 28.5% 28.5% 28.5% 28.5% 28.5% 28.5% 28.5% 28.5% 28.5% 28.5% 28.5% 28.5%After-Tax Cost of Debt 3.02% 3.02% 3.02% 3.02% 3.02% 3.02% 3.02% 3.02% 3.02% 3.02% 3.02% 3.02%

Cost of Preferred 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

MV Weight of Equity 60% 61% 62% 63% 64% 65% 66% 67% 67% 68% 68% 69%MV Weight of Debt 40% 39% 38% 37% 36% 35% 34% 33% 33% 32% 32% 31%MV Weight of Pfd 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%

Forward WACC 5.27% 5.29% 5.32% 5.35% 5.39% 5.44% 5.48% 5.52% 5.54% 5.55% 5.57% 5.59%

Discount Factor 1.0529 1.109003 1.168351 1.231351 1.29839 1.369519 1.445137 1.525144 1.609823 1.699475 1.794421

Implied Constant WACC 5.29% 5.31% 5.32% 5.34% 5.36% 5.38% 5.40% 5.42% 5.43% 5.45% 5.46%

British American TobaccoDiscounted Cash Flow (DCF) and Economic Profit (EP) Valuation Models

Key Inputs: CV Growth ‐1.33% CV ROIC 9.72% WACC 5.48% Cost of Equity 6.75%

Fiscal Years Ending Dec. 31 2019E 2020E 2021E 2022E 2023E 2024E 2025E 2026E 2027E 2028E 2029E 2030E(CV)

DCF ModelFCF 8,988.84 10,076.67 8,489.47 9,418.77 9,785.25 10,257.92 10,023.68 9,771.44 10,247.42 10,426.29 10,522.45 165,578.65 Discounted FCF 8,536.92 9,086.24 7,266.20 7,649.14 7,536.45 7,490.16 6,936.14 6,406.90 6,365.56 6,135.01 5,863.98 92,274.16 Value of Operations 171,546.85 Excess Cash ‐ STI 452 LTI 4,113 Equity in Unconsolitated Affiliates 517 Total Debt 60,555 PV Operating Leases 507 Minority Interest 238

115,329 Intrinsic Value 50.47$ per shareTime Adjusted 50.51$ per share

EP ModelEconomic Profit 3,804.11 3,533.99 3,607.94 3,591.39 3,514.20 3,719.48 4,001.85 3,975.80 4,202.82 4,348.80 4,423.70 61,920.75 Discounted Economic Profit 3,612.85 3,186.64 3,088.06 2,916.62 2,706.58 2,715.90 2,769.19 2,606.83 2,610.74 2,558.91 2,465.25 34,507.37 Sum of Future Cash Flows 65,744.95 Beginning Invested Capital 105,764.94

171,509.89 Excess Cash ‐ STI 452 LTI 4,113 Equity in Unconsolitated Affiliates 517 Total Debt 60,555 PV Operating Leases 507 Minority Interest 238

115,292 Intrinsic Value 50.45$ per shareTime Adjusted 50.49$ per share

British American TobaccoDividend Discount Model (DDM) or Fundamental P/E Valuation Model

Fiscal Years Ending 2019E 2020E 2021E 2022E 2023E 2024E 2025E 2026E 2027E 2028E 2029E 2030E(CV)

Key Assumptions CV growth 0.09% CV ROE 8.12% Cost of Equity 6.75%

Future Cash Flows P/E Multiple (CV Year) 14.86 EPS (CV Year) 4.02$ Future Stock Price 59.66$ Dividends Per Share 3.97$ Future Cash Flows 2.71$ 2.50$ 2.50$ 2.50$ 2.50$ 2.38$ 2.46$ 2.47$ 2.54$ 2.59$ 2.61$ 59.66$

2.54$ 2.19$ 2.06$ 1.93$ 1.80$ 1.61$ 1.56$ 1.47$ 1.41$ 1.35$ 1.27$ 29.09$ Discounted Cash Flows 48.27$

Intrinsic Value 48.31$ Time Adjusted 48.34$ per share

British American TobaccoRelative Valuation Models

EPS EPSTicker Company Price 2019E 2020E P/E 19 P/E 20IMB-GB Imperial Brands $34.34 $3.70 $3.86 9.28 8.90 2914-JP Japan Tobacco $24.95 $1.93 $1.99 12.93 12.54 PM Philip Morris $88.20 $5.26 $5.71 16.77 15.45 DDD Vector Group $10.87 $0.64 $0.65 16.98 16.72 EEE Swedish Match $50.81 $2.49 $2.79 20.41 18.21

Average 15.27 14.36

BTI British American Tobacc $40.75 3.55 2.81 11.5 14.5

Implied Relative Value: P/E (EPS19) $ 54.25 P/E (EPS20) 40.35$

UndervaluedFairly Valued

British American TobaccoKey Management Ratios

Fiscal Years Ending 2016 2017 2018 2019E 2020E 2021E 2022E 2023E 2024E 2025E 2026E 2027E 2028E 2029E 2030E(CV)

Liquidity RatiosCurrent Ratio 1.02 0.89 0.81 0.83 0.90 0.94 0.97 1.02 1.10 1.14 1.26 1.37 1.49 1.61 1.74 Operating Cash Flow Ratio 0.36 0.26 0.57 0.42 0.47 0.41 0.47 0.52 0.52 0.50 0.48 0.49 0.49 0.50 0.50 Quick Ratio 0.21 0.23 0.18 0.18 0.23 0.23 0.24 0.25 0.33 0.37 0.48 0.60 45% 44% 43%Activity or Asset‐Management RatiosDays of Inventory 130.02 111.08 85.77 85.08 85.08 93.08 86.23 86.23 86.23 86.23 86.23 86.23 86.23 86.23 86.23 Days to Collect Recievables 88.72 85.49 59.31 60.23 60.23 63.88 65.70 65.70 67.53 68.44 70.26 70.26 70.26 70.26 70.26 Asset Turnover 0.41 0.14 0.17 0.18 0.18 0.18 0.19 0.19 0.20 0.20 0.20 0.20 0.20 0.20 0.20 Profitability RatiosGross Margin 57.64% 58.95% 58.57% 58.54% 58.36% 57.84% 57.79% 57.76% 57.77% 57.79% 57.82% 57.84% 57.83% 57.80% 57.75%Net Income Margin 31.21% 185.44% 24.64% 23.98% 19.13% 23.46% 23.25% 14.73% 23.14% 23.41% 22.96% 23.09% 23.18% 23.24% 23.26%ROA 12.78% 25.34% 4.31% 4.33% 3.46% 4.30% 4.35% 2.87% 4.55% 4.69% 4.64% 4.70% 4.72% 4.70% 4.65%ROE 59.11% 58.37% 9.54% 9.40% 7.38% 8.97% 8.81% 5.72% 8.87% 8.91% 8.67% 8.65% 8.53% 8.35% 8.12%Leverage RatiosDebt / Assets 0.48 0.35 0.32 0.32 0.31 0.30 0.29 0.28 0.26 0.25 0.24 0.23 0.22 0.22 0.21 Debt / Equity 2.30 0.80 0.72 0.69 0.66 0.62 0.58 0.55 0.51 0.47 0.45 0.43 0.41 0.39 0.37 Debt / Capital (STD+LTD+Equity) 0.70 0.45 0.42 0.41 0.40 0.38 0.37 0.36 0.34 0.32 0.31 0.30 0.29 0.28 0.27 Debt / EBITDA 2.95 6.53 4.19 4.00 3.95 3.81 3.62 3.43 3.23 3.00 2.95 2.84 2.75 2.68 2.62 Payout Policy RatiosDividend Payout 68.15% 10.66% 76.87% 76.29% 88.98% 71.32% 70.71% 109.50% 65.00% 65.00% 65.00% 65.00% 65.00% 65.00% 65.00%

Beta Dividend Yield50.51$ 0.7 0.742 0.8 0.9 1 1.1 1.2 50.51$ 5% 5.50% 6% 6.47% 7% 7.50% 8%2.00% 57.26$ 54.90$ 51.81$ 46.91$ 42.49$ 38.49$ 34.88$ 21.00% 56.66$ 56.98$ 57.31$ 57.63$ 58.00$ 58.37$ 58.76$

Risk Free Rate 2.48% 52.67$ 50.51$ 47.68$ 43.19$ 39.13$ 35.45$ 32.11$ Marginal Tax Rate 23.50% 54.31$ 54.62$ 54.94$ 55.25$ 55.62$ 55.98$ 56.35$ 3.00% 48.14$ 46.17$ 43.60$ 39.50$ 35.79$ 32.42$ 29.36$ 26.00% 51.96$ 52.26$ 52.57$ 52.88$ 53.24$ 53.59$ 53.95$ 3.50% 44.16$ 42.37$ 40.01$ 36.25$ 32.84$ 29.74$ 26.91$ 28.50% 49.62$ 49.91$ 50.21$ 50.51$ 50.86$ 51.20$ 51.55$ 4.00% 40.53$ 38.88$ 36.72$ 33.27$ 30.13$ 27.27$ 24.65$ 31% 47.29$ 47.57$ 47.87$ 48.15$ 48.49$ 48.82$ 49.17$ 4.50% 37.19$ 35.68$ 33.70$ 30.52$ 27.63$ 24.98$ 22.56$ 33.50% 44.99$ 45.27$ 45.55$ 45.83$ 46.16$ 46.48$ 46.82$ 5.00% 34.13$ 32.75$ 30.92$ 27.99$ 25.31$ 22.87$ 20.62$ 35.00% 43.63$ 43.90$ 44.18$ 44.46$ 44.78$ 45.09$ 45.42$

Stategic Portfolio Growth50.51$ 3.5% 4.0% 4.5% 5.0% 5.5% 6.0% 6.5% Cost of Debt1.00% 50.61$ 53.02$ 55.54$ 58.19$ 60.97$ 63.87$ 66.91$ 50.51$ 3.50% 3.75% 4% 4.23% 4.50% 4.75% 5%

NOPLAT CV Growth 0.00% 47.60$ 49.67$ 51.84$ 54.11$ 56.49$ 58.97$ 61.57$ 5.50% 65.49$ 64.46$ 63.46$ 62.56$ 61.53$ 60.60$ 59.70$ -1.00% 45.51$ 47.34$ 49.26$ 51.27$ 53.37$ 55.57$ 57.86$ Cost of Equity 6.00% 59.92$ 59.04$ 58.17$ 57.39$ 56.50$ 55.70$ 54.92$ -1.33% 44.94$ 46.71$ 48.57$ 50.51$ 52.53$ 54.65$ 56.86$ 6.50% 54.87$ 54.11$ 53.36$ 52.68$ 51.90$ 51.21$ 50.54$ -1.50% 44.68$ 46.42$ 48.24$ 50.15$ 52.14$ 54.22$ 56.40$ 6.75% 52.53$ 51.82$ 51.12$ 50.51$ 49.76$ 49.11$ 48.48$ -1.75% 44.31$ 46.01$ 47.79$ 49.65$ 51.59$ 53.62$ 55.74$ 7.00% 50.29$ 49.63$ 48.97$ 48.38$ 47.70$ 47.10$ 46.51$ -2.00% 43.96$ 45.62$ 47.36$ 49.18$ 51.08$ 53.06$ 55.13$ 7.50% 46.12$ 45.54$ 44.97$ 44.45$ 43.86$ 43.33$ 42.82$

8.00% 42.31$ 41.81$ 41.30$ 40.85$ 40.33$ 39.86$ 39.42$ COGS %

50.51$ 36% 36.50% 37.0% 37.50% 38% 38.50% 39% CapEx Growth0.00% 60.36$ 59.39$ 58.42$ 57.45$ 56.00$ 55.51$ 54.54$ 50.51$ 0.20% 0.30% 0.40% 0.50% 0.75% 1.00% 1.50%

Other Combustiles Growth -1.00% 58.63$ 57.68$ 56.74$ 55.79$ 54.36$ 53.88$ 52.93$ 18.0% 53.39$ 53.34$ 53.30$ 53.25$ 53.14$ 53.02$ 52.79$ -3.00% 55.64$ 54.72$ 53.81$ 52.89$ 51.52$ 51.06$ 50.15$ SG&A % 18.5% 52.47$ 52.43$ 52.38$ 52.34$ 52.23$ 52.11$ 51.88$ -5.00% 53.16$ 52.28$ 51.39$ 50.51$ 49.18$ 48.74$ 47.87$ 19.0% 51.55$ 51.51$ 51.47$ 51.42$ 51.31$ 51.20$ 50.98$

-7% 51.12$ 50.26$ 49.40$ 48.54$ 47.27$ 46.84$ 46.00$ 19.5% 50.64$ 50.60$ 50.55$ 50.51$ 50.40$ 50.29$ 50.07$ -9.00% 49.43$ 48.59$ 47.76$ 46.93$ 45.70$ 45.29$ 44.47$ 20.0% 49.72$ 49.68$ 49.64$ 49.59$ 49.49$ 49.38$ 49.16$

-11.00% 48.05$ 47.23$ 46.42$ 45.62$ 44.41$ 44.02$ 43.22$ 20.5% 48.81$ 48.77$ 48.73$ 48.69$ 48.59$ 48.48$ 48.27$ 21.0% 47.91$ 47.87$ 47.83$ 47.79$ 47.69$ 47.59$ 47.38$

Consumer Staples British American Tobacco ADR (NYSE: April 11, … · 2019-04-19 · The United...

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Transcript of Consumer Staples British American Tobacco ADR (NYSE: April 11, … · 2019-04-19 · The United...