Currently, British American Tobacco (BTI) is one of my largest stock holdings, a stock that I have owned since 2021. BTI is the largest tobacco company by sales, selling traditional tobacco products but also innovating in smokeless nicotine products. Tobacco stocks have been out of favor the past couple of years, with lackluster share prices. This depressed share price, and BTIs 7.5% dividend yield begs the question as to whether the company is currently trading below intrinsic value. In this post I will do a rough valuation of British American Tobacco in order to see if the stock is a bargain.
The first place I am going to start with valuing BTI is approximating their normalized operating earnings. Over the past 5 years, British American Tobacco has produced around $12B in operating earnings. This is slightly less than the 2022 figure of $12.6B, so I will use the more conservative figure of $12B.
BTI usually pays around a 25% tax rate. Applying this rate to the estimated operating earnings produces an after tax earnings of $9B.
Next, I capitalize the estimated after tax earnings to produce an enterprise value. Typically I estimate a cost of capital based on historical P/E ratios, and also factor in the size and quality of the business. In recent years, BTI has been trading at a fairly low multiple. Prior to the large acquisition they made in 2017, British American Tobacco was regularly trading over 25 times earnings. Currently the company has an $80B market cap, which makes it a large cap. The high margins and large amount of cash produced by the company suggests some quality. On the flip side, tobacco companies are in favor with investors, which could produce higher cost of capital. For this analysis, I will use a discount rate of 6.7%. Capitalizing the $9B in after-tax earnings using this rate produces an enterprise value of $134B.
In order to convert the enterprise value into an equity valuation, the long term debt is subtracted from the EV, and the cash balance is added back. BTI has about $46.5B in debt, and about $4.1B in cash. This produces an estimated fair value market capitalization of $91.6B.
Dividing the fair value market cap by the 2,267M shares outstanding, we arrive at a fair value stock price around $40. The current market price is around $35, indicating that BTI may be slightly undervalued. One thing that is in British American Tobacco’s favor is that they have historically paid out most of their cash flow out as dividends. Currently the stock has quite a large dividend yield, over 7.5%. Perhaps if investors bid up the stock to produce a more normal dividend yield, the stock would be worth more than my $40 estimate.