Background
British American Tobacco Plc (BAT) has established 45 factories in around 39 nations, these factories engage in production, supply and trade of the tobacco products. BAT provides cigarettes, cigars, roll-your-own, pipe tobacco as well as smokeless snus goods under the Kent, Pall Mall, Kool, Dunhill, Viceroy, Vogue, Lucky Strike, Benson & Hedges, Rothmans, State Express 555, and Peter Stuyvesant brand names (Bat.com, 2011). It operates in the America, Asia-Pacific, Africa, Middle East and Western Europe: BAT was instituted in the year 1902 and it has head office in London, UK (Bat.com, 2011: Finance.yahoo.com, 2011).
The firm’s portfolio is made up of at least 200 brands and holds a strong market positions in every region of operations and leads in at least 50 markets. In the year 2010, its subsidiaries sold 708,000 million cigarettes and enabled governments globally to collect at least £30,000 million in taxes, together with products excise duty that was approximately ten times firm’s net profit (Bat.com, 2011). BAT has sustained considerable international presence for more than 100 years since its establishment in the year 1902 and in the year 1912 the firm emerged to be among world’s top firms by measure of the market capitalization (Bat.com, 2011). The company is listed on the London Stock Exchange with a ticker symbol BATS.L and a market capitalization of £58.58 billion (Bat.com, 2011). The company’s stock’s 52-week range, low and high, is 2,245.88 – 2995.00p and on December 2, 2011 the stock closed the day at 2,956.50p (Finance.yahoo.com, 2011)
Market overview
The worldwide tobacco industry manufactures at least 5,400,000 million cigarettes each year. China offers the largest market, where tobacco industry is owned by the state, with approximately 0.35 billion smokers accounting for at least 40% of the international total. Four global tobacco firms; BAT, Philip Morris International, Imperial Tobacco and Japan Tobacco account for about 45% of the international market or approximately three-quarters of global market, excluding China (Guardian.com, 2011). A maximum of 12% of the international volume of tobacco products are sold on black market due to illegal trade in the tobacco products (Ibisworld.com, 2011).
The international environment is still uncertain and tough. Whilst a number of emerging markets might grow fast in the year 2011, recovery in the developed nations is expected to be delicate for some period as well as the increasing unemployment levels are major concern (Hunkar, 2010: Guardian.com, 2011).
The four biggest tobacco firms face an intensive competition in the market but generally the industry’s value is still increasing. There are many opportunities to develop the price and product mix, mainly in the developing nations. BAT deems that consumers are gradually looking for more and anticipating real value, so innovation and quality play the main function in delivering the market share (Hunkar, 2010: Ibisworld.com, 2011).
Illegal trade in the tobacco products
In black market, cigarettes are the major products being traded as a result of their superior profit margins, low penalties and detention rates, and comparative ease of manufacture and supply. The main drivers of illegal trade are the economic factors like inexpensive cigarettes for clients and income for counterfeiters and smugglers. Contributing factors comprise of rapid increases in the excise, ineffective sanctions and weak controls in the borders (Johnson, 2010: British American Tobacco, 2010).
Educated guess proposes that a maximum of 660,000 million illicit cigarettes products are smoked each year; this affects the consumers, government, tobacco firms and retailers negatively (Johnson, 2010). For the consumer, illicit cigarettes may mean fake cigarettes without quality controls and without warnings for health or in case genuine cigarettes are smuggled, warnings for health do not comply with the regulations of the local government. The government on the other hand, loses ÂŁ24,000 million each year in the excise duty and various other taxes, whilst the legitimate tobacco firms losses approximately ÂŁ6,000 million in revenue each year (Johnson, 2010: British American Tobacco, 2010).
The BAT deems that dealing with this illicit trade efficiently requires collaboration between the regulators, enforcement authorities and the industry. BAT supports governments’ introductions of the suitable tax policies, well-built regulations and efficient enforcements. In the year 2010, BAT signed a collaboration accord with European Commission and European Union’ member nations to deal with the issue of illegal trade (British American Tobacco, 2010).
Industry overview
The consumption trends in the world show that smokers will use smaller amount of cigarettes each and lesser populations’ proportion will smoke. But with the increase in the global population to at least 7 billion by 2012 and 9 billion by 2050, BAT deems that the industry will be sustainable in the long-range (Johnson, 2010).
Regulation on the other hand, is turning out to be more severe, with support from World Health Organization’s Framework Convention on Tobacco Control. Suitable health warnings printed on packs as well as other key packaging have for a long time been the industry’s practice. But a shift towards plain tobacco products’ packaging could make lives easier for criminals and counterfeits cigarettes would turn out to be easier to manufacture and branded illegal cigarettes products, which do not conform to regulations and could be more striking to the consumers. Retail exhibit bans could as well result to a rise in illegal trade through driving legal products’ sale underneath the counter and alter competition amongst tobacco firms (Hunkar, 2010: Guardian.com, 2011).
Most governments utilize tobacco taxation in order to reduce smoking rates, at the same time increasing important excise revenue. But rapid excise rates increase can undermine the markets and may lead to consumer shifting to the inexpensive illegal products. Steady and expected increases in the excise may be more efficient for the governments, assisting to uphold a systematic market, which enables tax incomes to be raised as well as support the policy of public health (Topforeignstocks.com, 2010: Mazars.cn, 2011).
Competitors
For the purpose of the comparative analysis this study will consider two major competitors of BAT; Imperial Tobacco Group Plc and Philip Morris International Inc. Imperial Tobacco Group Plc produces, distributes and sells a wide range of tobacco products. The company’s products include roll-your-own, pipe tobaccos, filters, cigarettes, tubes, rolling-paper products and cigars (Imperial Tobacco, 2010). The firm sells all of its tobacco products under various brand names such as Classic, Excellence, Gitanes, Gauloises Blondes, West, Lambert & Butler, Davidoff, Drum, Maxim, Fortuna, Windsor Blue, Sonoma, Golden Virginia, Richmond, John Player Special, Rizla and USA Gold ((Imperial Tobacco, 2010). The group mainly operates in Germany, Spain, UK, and the rest of European Union, US, Middle East, Africa, Asia-Pacific and Eastern Europe. The firm was established in 1901 and its head office is in Bristol, UK (Imperial Tobacco, 2010: Imperial-tobacco.com, 2011).
Imperial Tobacco is listed in London Stock Exchange with a ticker symbol IMT.L. and has a market capitalization of £23.23 billion and the stock’s 52-week range, low and high, is 1,665.51 – 3,028.00p and on December 2, 2011 the stock closed the day at 2,296.00p (Finance.yahoo.com, 2011).
Philip Morris International Inc. produces and sells tobacco products. The firm’s portfolio of local and international brands includes Merit, Virginia Slims, Marlboro, Parliament, Bond Street, L&M, Next, Red and White, Lart, Philip Morris, Muratti, and Chesterfield (Philip Morris International, 2010). The firm’s local brands consist of Sampoerna Hijau, Dji Sam Soe and Sampoerna A in Indonesia; Italy’s Diana; Philippines’ Hope; Apollo-Soyuz and Optima in Russia; Colombia’s Boston; Pakistan’s Morven Gold; and Classic and Best in Serbia among others (Philip Morris International, 2010). The firm operates in around 180 nations in Eastern Europe, European Union, Asia, Canada, Middle East, Asia, Africa and Latin America; the firm was established in the year 1987 and its head office is in New York (Philip Morris International, 2010: Pmi.com, 2011).
The firm is listed in New York Stock Exchange with a ticker symbol PM and market capitalization of $131.09 billion. The stock’s 52-week range is $55.85-$77.00 and on December 2, 2011 the firm’s stock closed the day at $75.47 (Finance.yahoo.com, 2011).
Financial performance
This section will evaluate financial performance of BAT using ratio analysis in the last three years that is from 2008 to 2010, what is termed as trend analysis. Comparative analysis will also be carried out with BAT’s competitors.
Profitability
Profitability ratios measure the management effectiveness as shown by the turnover generated on sales and investment (GoldmanSachs.com, 2010). Profitability ratio as measured by Gross Profit Margin indicates that BAT’s profitability had reduced in 2010 with a margin of 2.88% compared with 2009; also the ratio indicates that in 2008 the profitability was high compared with 2010. This means the firm was less efficient in controlling cost of sales in 2010 compared with 2008 and 2009. Compared with its two competitors, Imperial Group and Philip Morris International, the firm was underperforming meaning that the competitors were more efficient in controlling their cost of sales and their sales levels were higher than BAT. Thus, competitors sold more tobacco products and they had a huge market share than BAT.
Based on operating profit margin the firm’s profitability had reduced in 2009 by a margin of 0.61% and improved in 2010 by a margin of 0.15%. This implies that the firm was less efficient in controlling its operating costs in 2009 compared with 2008 and more efficient in controlling costs of operations in 2010 compared with 2009 as shown by the increase in the ratio. Compared with the competitors, the firm was over-performing in controlling cost of operations since the competitors’ ratios were less than that of BAT with Philip Morris International being the least efficient firm as shown on Table 1.
Net profit margin indicates that the firm was more efficient in controlling or managing the cost of sales, operating costs and finance costs in the year 2010 compared with 2009 as shown by the increase in the ratio. Therefore, in 2009 the firm performed poorly in cost control compared with 2008 and 2010. Just like operating profit margin the firm performed better than its competitors who were not efficient in controlling their operating costs and financing costs.
Return on assets ratio indicates that the firm’s profitability position had improved throughout the years from 2008 to 2010 since the ratio increased from 9.65% in 2008 to 11.27% in 2010. This implies that the firm was efficient in utilization of its assets to generate returns to the providers of those funds. Compared with the competitors, the firm was more efficient than Imperial Tobacco but less efficient than Philip Morris International.
Finally, profitability as measured by Return on Equity shows that in 2009 there was an increase in profitability and the firm’s ability to generate returns to equity shareholders from owners’ supplied funds. The ratio dropped by a margin of 4.47% in 2010 meaning that the profitability reduced and the company was unable to generate returns to equity shareholders from owners’ supplied funds. The firm was less profitable than Philip Morris International and more profitable than Imperial Tobacco.
Table 1: Profitability
Liquidity
Liquidity ratios measure the firm’s ability to meet its short-term maturity obligations to its creditors and they measure liquidity risk of the firm (Microstrategy.com, 2011). The liquidity ratios as measured by current and quick ratio indicate a decline in the company’s liquidity position from 2009 to 2010. The quick ratio decline as compared to current ratio declined shows that the firm holds a significant amount of its current assets in stock. If the trend continues, it implies that the firm will not be able to meet its short term obligations on time as current liabilities will not be subsequently covered by the current assets.
The firm was over-performing in terms of liquidity as compared with its competitors implying that the company holds a lesser amount of current liability as compared with its main competitors as shown by Table 2.
Table 2: Liquidity
Leverage
Leverage ratios measure the extent to which a firm uses the assets which have been financed by non-owners supplied funds; that is they measure the financial risk of the company (Drake, 2009). The leverage ratios as measured by debt ratio and debt-equity ratio show a decline in the firm’s leverage from 2008 to 2010. As measured by debt ratio, in 2008, 2009 and 2010 the firm raised 73.81%, 70.27% and 65.73% of debt from the total capital employed respectively. The level of gearing was not satisfactory since it was more than 50%, the reduction in the gearing may be as a result of decrease in the liability level in 2009 and 2010. Compared with competitors the firm was less geared and Philip Morris International was the most geared firm compared to the other two firms.
As measured by debt-equity the firm leverage reduced from 122.75% in 2009 to 93.38% in 2010, this means the firm was not highly geared as the ratio in 2010 was not more than 100%. The firm was less geared compared to its competitors. This was as a result of less long-term loans acquired in 2010 by BAT compared to its competitors as shown by Table 3. Thus, BAT was facing high financial risks as a result of using more debt.
Table 3: Leverage
Activity
Activity ratios measure the efficiency with which a firm uses its assets to generate sales (Meir, 2008). Efficiency as measured by fixed asset turnover and total asset turnover indicates that the efficiency of managing assets to generate return had improved from 2008 to 2010. In 2010, 2009 and 2008, as measured by fixed asset turnover, the firm generated ÂŁ0.78, ÂŁ0.77 and ÂŁ0.64 of sales respectively, from every pound invested in fixed assets. This implies that the firm managed fixed assets effectively as shown by an increase in the ratio. Compared with its competitors BAT over-performed relative to Imperial Tobacco and underperformed compared with Philip Morris International.
As measured by total asset turnover the firm’s efficiency of managing its assets improved as shown by increase in the ratio from 2008 to 2009 but in 2010 the ratio remained constant. In 2010, 2009 and 2008, the firm generated £0.53, £0.53 and £0.44 of sales respectively from every pound invested in current and fixed assets. The firm underperformed and over-performed compared with Philip Morris International and Imperial Tobacco respectively.
Table 4: Activity
Evaluation
Evaluation/investors ratios are used to evaluate the overall performance of the firm (Essortment.com, 2011). According to the firm’s EPS, in 2010, 2009, 2008 every share invested in the firm generated 145.20p, 137.02p and 123.28p of the company’s earnings respectively. This implies that the profitability of the firm on a per share basis had increased from 2008 to 2010. The firm underperformed compared with Imperial Tobacco and Philip Morris International, thus those who invested in BAT expected to generated less earnings for every share invested in the firm.
P/E ratio indicates that the investors in 2008, 2009 and 2010 would take 2.93, 7.71, 16.97 years respectively to recover their initial investment in the shares from the earnings generated by that investment in the firm. The competitors’ investors would take fewer years, 13.25 and 14.47 for Imperial Tobacco and Philip Morris International in 2010 respectively, to recover their initial investment in the shares from the earnings generated by that investment in the competitors’ firms. This implies that the BAT investors in 2010 will take more years to recover their initial investment compared with competitors’ investors; this is as a result of lower earnings generated by the BAT in a per share basis as shown by Table 5.
Table 5: Evaluation
Conclusion and Recommendation
BAT is facing high financial risks as a result of use of more debt thus it has to reduce its risks by reducing the amount of debt this maybe through issuing more shares to shareholders through right issue so as to reduce the debt-equity ratio. It also has to improve its liquidity through use of less current liabilities or improve its credit policy by selling on credit to customers so as to improve liquidity and profitability. Therefore, it should effectively utilize assets and shareholders’ funds to generate returns.
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