British American Tobacco plc (BATS): Is It an Exciting Emerging Market Play?

LONDON — While crippling austerity in Europe and fiscal obstacles could put the brake on growth rates there, in developing regions a backdrop of accommodative central bank action, elevated commodity prices, and rising personal affluence levels have created an environment of exceptional commercial opportunity.

The divergence between the growth prospects of traditional and developing markets is borne out by latest International Monetary Fund’s (IMF) growth projections, which expect developing nations and emerging markets to expand 5.3% and 5.7% in 2013 and 2014, respectively. By comparison, it anticipates that the US economy will rise 1.9% this year and 3% in 2014, while eurozone GDP is forecast to dip 0.3% in 2013 before rebounding just 1.1% next year.

Bubbly activity in these developing geographies can create large opportunities for many London-listed firms. Today, I am looking at British American Tobacco plc (LON:BATS) and assessing whether its operations in these regions are likely to underpin solid earnings growth.

Asia-Pacific demand continues to surge
British American Tobacco plc (LON:BATS) advised in yesterday’s interims that group revenue rose 5% at constant exchange rates in the January-March period, although total cigarette volumes dropped 3.7% to 160 billion sticks. The company noted, however, that it witnessed solid demand growth in many markets, particularly Bangladesh, Vietnam, and Pakistan. Indeed, demand from the particularly lucrative Asia-Pacific region advanced 6.7% on-year to 48 billion sticks.

By comparison, Western European demand slumped 10.3% to 26 billion, and consumption from the Americas fell 13.5% to 32 billion, although substantial trade inventory movements in key customer Brazil accounted for much of this. Demand from Eastern Europe, the Middle East, and Africa nudged marginally lower to 54 billion.

Despite falling volumes, British American Tobacco plc (LON:BATS) was still able to post revenue growth due to the considerable pricing power of its “Global Drive Brands” stable, comprising Lucky Strike,Dunhill, Pall Mall and Kent. Despite weakening demand elsewhere, total demand for these labels rose 1% in the first quarter.

Specifically, solid growth in Indonesia, South Korea, and the Middle East drove Dunhill sales 5% higher, while Pall Mall volumes jumped 9%, helped in part by rising demand from Pakistan and Chile.

An estimated 80% of all cigarette demand originates from developing regions, leaving the firm in pole position to latch onto growing demand in these markets. The company, which already operates in more than 180 markets, is stepping up activity in emerging regions to drive future growth. It invested heavily in Indonesia last year and launched its Dunhill brand in the country last spring, which represented the fastest-growing and most successful introduction of an international “kretek” brand there.