British American Tobacco (BAT) continued to outperform the tobacco market in 2014.  The group is also investing US$4.7bn to maintain its 42% stake in the American tobacco group Reynolds.  BAT saw solid underlying progress in revenue and profits in 2014 but currency headwinds hit the reported results.

On face value it seems strange that the global tobacco groups have delivered such strong returns for investors.  This is, after all, a declining industry with global cigarette volumes estimated to have fallen by 2.5% in 2014.

Western countries are certainly increasing taxes on cigarettes and discouraging the uptake of smoking.  Advertising and smoking in public places are generally banned and more recently we have seen a move to plain packaging.

Cigarette Packaging under threat


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Source: BAT website

In the UK 45% of people were smokers in 1974 but by 2013 the figure had fallen to 19%.  However, tobacco groups are being managed to absorb this decline and have lifted their profit margins and return on capital.

Industry consolidation has been one driver of higher returns while the ban on advertising has reduced costs.  As a mature industry the dividend payout ratios are generally high and share buy backs have boosted earnings per share.

Turning to British American Tobacco (BAT) and it has seen resilient volumes due to its emerging market exposure and Global Drive Brands.  The global cigarette market saw a 2.5% volume fall in 2014 but BAT's decline was only 1.4%.

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Source: BAT investor presentation

The two most important regions for BAT by volume of cigarettes actually saw an increase in sales last year.  Asia Pacific saw a 0.1% gain and Eastern Europe, Middle East and Asia (EEMEA) saw a 0.3% improvement.

Global Drive Brands have also been important with a 5.8% increase in the volume of sales in 2014 to 278bn.  This supported volumes and also revenue growth because the five Global Drive Brands are premium products sold at higher prices.

Two of BAT's five Global Drive Brands

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Source: BAT investor presentation

Turning to the financial results and BAT saw a 2.8% increase in revenue in 2014, at constant currencies, despite the 1.4% fall in volumes.  With the profit margin up 0.5%, and share buy-backs continuing, earnings per share (EPS) rose 7.9%.

However, factoring in the currency impact and the picture was not as robust with reported revenue down 8.4% and EPS…

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