British American Tobacco is a major tobacco company headquartered in London. This report analyzes BAT's stock to estimate a fair price. Financial data from the past 5 years was collected and ratios were calculated. A forecast for the next 3 years was made. Using a discounted dividend model, the actual stock value was estimated at £45.75, 22% higher than the current price of £37.465. Therefore, the report recommends buying BAT shares.

1. British American Tobacco,
PLC
Equity Report
by M. Lipan, J. Malek, J. Teichman & T. Krejci
4/30/2015

2. 1
British American Tobacco, PLC
Price Summary: Key Statistics:
Executive Summary
The main goals of this report are to provide a comprehensive summary of an equity analysis that was
elaborated in order to closely estimate a fair price of the British American Tobacco stock shares and to
put this public company into context of the corresponding industry.
To run the analysis, data from past five years was first collected and informative accounting rations
obtained to yield a link between real events and financial statements. Based on additional closely
gathered data, an explicit forecast of the relevant figures for the three following years was then made
with a convergence to a horizon in 2021. Subsequently, a discounted dividend model was used to obtain
the actual value of a share. All the supporting calculations including the dividend discount analysis can be
found in the supplemental .xls file.
Since the final estimate of the actual stock price to the date 4/30/2015 obtained by the described
procedure was approximately 22% higher than the price at which the shares are currently traded at the
FTSE, the ensuing conclusion is that the prices of BAT shares are temporarily undervalued and the
subsequent recommendation is that such shares should be bought in order to make a future profit.
BUY
Traded price £37.465
Estimated price £45.75
Upside 22.11%
52wk range 3,303.000 - 3,894.000
Volume 1,293,456
Market Capitalization 67,360.41
Share Outstanding 1,864.13
Price/Book (mqr) 12.1552
Estimated P/E 17.2812
Historical Share Price (3y Time-Span)

3. 2
Contents
Company Overview/Introduction ………………………………………………………………………………………… 2
SWOT Analysis ………………………………….…………………………………………………………………………………… 4
Strengths ……………………………………………………………………………………………………………………………… 4
Weaknesses ………………………………………………………………………………………………………………………….. 4
Opportunities …………………………………………………………………………………………………………………....... 5
Threats …………………………………………………………………………………………………………………………………. 5
Porter’s Five Forces Analysis ………………………………………………………………………………………………… 6
Threat of New Entrants ……………………………………………………………………………………………………….. 6
Bargaining Power of Suppliers ……………………………………………………………………………………………… 6
Bargaining Power of Buyers ……………………………………………………………………………………………….. 6
Threat of Substitutes ………………………………………………………………………………………………………….. 7
Intensity of Rivalry in the Industry ……………………………………………………………………………………… 7
Income Statement Issues ……………………………………………………………………………………………………. 7
Efficiency measures ……………………………………………………………………………………………………………. 8
Inventory turnover ……………………………………………………………………………………………………………… 8
Receivables and Payables Turnover …………………………………………………………………………………….. 8
Asset Turnover …………………………………………………………………………………………………………….……… 8
Liquidity and Solvency Measures ………………………………………………………………………………………… 9
Profitability Measures ………………………………………………………………………………………………………… 10
Dividend …………………………………………………………………………………………………………………………….. 11
Sensitivity Analysis ………………………………………………………………………………………………………….. 12
Forecast ……………………………………………………………………………………………………………………………… 12
Sales Growth ………………………………………………………………………………………………………………………. 12
Profit Margin after Tax …………………………………………………………………………………………………………. 13

4. 3
Asset Turnover ……………………………………………………………………………………………………………………. 13
Financial Leverage ………………………………………………………………………………………………………………. 13
Net Operating Assets ………………………………………………………………………………………………………….. 13
Return on Financial Assets, Borrowing Costs ……………………………………………………………………….. 13
Financial Liabilities/Net Financial Liabilities ………………………………………………………………………….. 13
Effective Tax Rate ………………………………………………………………………………………………………………… 14
Valuation ……………………………………………………………………………………………………………………………. 14
Work Cited …………………………………………………………………………………………………………………………. 14

5. 4
Company Overview/Introduction
The British American Tobacco Group is one of the world’s major producers of tobacco based products. It
is a company of an ample tradition and concrete establishment, as it originated by a merger of American
Tobacco Company and Imperial Tobacco Company as early as in 1902. Today, BAT is headquartered in
London, UK controlling over one seventh of the world cigarette market, employing over 57,000 people and
selling over 700 bn. cigarettes every year under a wide variety of brands including Dunhill, Kent, Lucky
Strike, Pall Mall and many others.
Despite the government restrictions, the tobacco industry has been fairly stable for well over the last two
decades. This fact together with a highly sophisticated oligopoly structure built roughly over the same
period of time is in most cases allowing the individual firms to achieve steady earnings. In fact, revenues
and net earnings of BAT were until the last year despite the ever growing anti-smoking legislations in
developed countries on a rise. Reason of that being the newly emerged and growing cigarette markets in
Asia, Africa and even South America and the markets of less controversial cigarette alternatives in the
countries of North America and Western Europe.
SWOT Analysis
Strengths
Being a company with a long tradition, BAT was not surprisingly able to achieve a fair amount of stability
on multiple markets that nowadays amount to over 200. That, combined with the already established
oligopoly of the global tobacco industry, allowed the BAT to earn steady profits which makes it quite
attractive for conservative investors.
Derived from this presence in multiple markets is another major advantage, which is the wide
diversification of both the distributed brands and the target consumers, allowing BAT group further
mitigation of any possible adverse fluctuations in individual markets.(UK Essay)
Weaknesses
Much like other producers of tobacco based products, BAT suffers from a high and frequent exposure to
lawsuits of consumers whose health has suffered from smoking. A considerable amount of every year’s

6. 5
earnings is subsequently spent to cover the legal costs, making the yearly allowance for such expenditures
a necessary item on the firm’s financial statements.
Another issue is the nature of BAT’s production. Even though it does not specialize solely on a production
of cigarettes (it also produces snus and has recently launched new products including variety of e-
cigarettes), the cigarette sales are still responsible for a vast majority of its revenues, which makes the
company heavily dependent on a set of closely related products.
Opportunities
Even though the smoking regulations in the US and Europe have over the years successfully reduced the
number of smokers, there are newly emerging markets in developing countries of Africa (Nigeria), Asia
(Pakistan), Pacific or South America. Even though there has been a pressure from the World Health
Organization to enforce similar legislation as in the developed countries, the higher sales in these new
markets have been able to compensate for the declining demand in the original countries of export.
In addition, the consumer preferences are nowadays shifting towards nicotine containing products that
carry lower amount of risk. While the first attempts to attract consumers with such preferences that took
place over two decades ago turned out to be rather unsuccessful, today the electronic cigarettes are on a
rise and according to Bloomberg Industry, their sales should be surpassing the sales of traditional
cigarettes by 2047 (Robehmed). Naturally, BAT much like its competitors, sees a great potential of this
market and in 2013 it has already launched its own brand of e-cigarette, Vype.
Another growing market consists of the women smokers. Traditionally the portion of the smokers in
population was almost negligible whereas nowadays the share of women who are smoking is quite
significant. In US the portion of women smokers is today close to 15% which is only about 5% less than the
smoking rate for men.
Threats
Naturally, much like for any major tobacco related firm with relatively stable earnings the biggest concern
of BAT shareholders is the spreading awareness of the health effects of smoking which could results in
adverse shift of demand and also in governments passing further regulations of the cigarette distribution
or sale.

7. 6
Additional threat arises from the high global level of competitiveness in the tobacco industry. As described
further on, BAT has a large and stable market shares in most of the individual markets where it is currently
present and active, but its overall share of the global market could be relatively quickly brought down by
its incapability to maintain the quality of its products or the low production costs.
Porter’s Five Forces Analysis
Threat of New Entrants
It would be light-headed to think that due to generally known barriers to enter the tobacco market there
are only very few competitors at play. In fact, on the local level the barriers of entry are relatively low and
consequently there is a number of competitors for each individual state or county (or their equivalents in
countries other than US). The true barriers of entry are at the national and global level. Due to multiple
restrictions to the advertisement that have been gradually passed in the developed countries, it is
nowadays highly costly to compete with the well established companies that are in addition economies of
scale such as BAT and their brands that have been sold since before the restrictions were even passed into
legislation.
Bargaining Power of Suppliers
Tobacco is in general a crop that is not very demanding concerning the weather or climate overall, which
makes it possible to be grown in basically any part of the globe and thus relatively easily attainable in
desired quantities. As a result, the market for raw tobacco employs many competitors and by its structure
resembles the pure competition. Combined with the overall low levels of tobacco tariffs in the US and UK
this means that the producers of cigarettes and other tobacco related goods are able to meet their demand
while having an option to choose from a variety of different suppliers. This means that the bargaining
power of tobacco sub-suppliers is nowadays fairly low.
Bargaining Power of Buyers
Perhaps quite counterintuitive is the size of bargaining power of the consumer. While a single buyer is
generally believed to have only the option of substitution for a less expensive brand in case of rise in price
in his current choice brand, in actuality it is the rising health awareness of the buyers that have resulted in
the widespread government regulations that today represent one of the major hurdles for the profit

8. 7
seeking companies in the industry. Because of this, both BAT and its competitors are now forced to move
considerable volumes of their sales into the newly emerging markets in countries with lower tobacco
duties and advertisement regulations.
Threat of Substitutes
For smokers there is clearly no close substitute in the traditional sense and equivalent price range.
Furthermore, because of the usual proportions production volumes of the cigarette manufacturers, it
would be very difficult for producers of such substitutes to compete with the prices set by economies of
such large scales.
However, since cigarettes are by its nature not essential for life, the ever more attractive substitute for
smokers is simply to stop using any tobacco related products altogether. Substitute medical products that
contain the addictive substance nicotine are today easily accessible making possible for smokers to quit.
Intensity of Rivalry in the Industry
Looking at the global market of tobacco products there are mostly just three firms competing to seize it.
Apart from BAT it is also the Phillip Morris of the Altria Group (15.4% share of the global market), Japan
Tobacco (11% share), Imperial Tobacco (6% share) and China National Tobacco Company. However, even
though the level of competitiveness in United States, Mexico and in Asia is quite high due to presence of
many brands BAT takes advantage of its well established networks in the countries of Commonwealth
(Nigeria, Southern Africa, Dem. Rep. of Congo, etc.) and South America (Brazil, Venezuela, Chile) where it
is easier to make positive profits due to lesser sales and advertisement regulations and where BAT holds
the majority shares of markets.
Income Statement Issues
Before we started our analysis, we had to deal with some non-standard income statement reporting
practices and adjust reported numbers.
Generally, problem lied in nonexistence of direct COGS, SG&A, D&A features. Most of the mentioned was
hidden in foggy items which were grouping the figures loosely and misleadingly. After deep analysis of
enclosed statements notes, we discovered the reason why such approach had been applied. The
company’s attempt was to include unusual non-operating activities in the operating part of the income

9. 8
statement to mask some unfavorable M&A and goodwill impairment costs (for more look in the excel,
sheet “IS restated”). After we adjusted for these items and restated the income statement, we approached
standardly reported figures, among others COGS, SG&A, D&A, EBIT, EBITDA. These adjusted numbers
became a basis for out further work.
Efficiency measures
Inventory turnover
Continuous decrease in inventory turnover signalizes problem with selling inventories. Moreover the ratio
is significantly below the industry average, which indicates less efficient management of inventories
compared to competitors. For year 2014 ITO accounted for 0,74 whereas the industry average was 4,2
times higher.
Receivables and Payables Turnover
Again, receivables turnover (4,95) is lower than industry average (19,42), but more importantly it
significantly decreases during the monitored period. This can be a sign of problems with collecting its due
payments. Moreover, accounts receivable grew faster than sales during the period. This means that share
of sales on credit increases. Eventually, this ratio should be monitored really closely as it can evolve into
significant problem.
Very low payables turnover (0,54) indicates that it takes very long time to the company to pay its due
payments, in our particular case more than two years on average. Moreover, the length of payments
slightly and steadily prolongs. When we have closer look on this issue, it can be revealed from the notes
in Annual reports of the company that big and stable portion of current liabilities consist of duty, excise
and other taxes which is naturally connected to the tobacco industry. The long retention of tax liabilities
is probably the cause of such low APTO which is far below the industry average (15,17). Due to the stable
company’s payables policy and mentioned reasons, we do not find this ratio potentially dangerous.
Asset Turnover
The asset turnover was stable in time. Slight decrease can be observed during 2014 which was definitely
caused by decrease in net sales. In general, company’s asset turnover is slightly lower than industry
average.

10. 9
Measures mentioned above are signs that cause concern about the efficiency of performance of the
company and may result in serious problems in future.
Liquidity & Solvency Measures
Current ratio (1,04) is below industry average (1,55). In 2014, there was a drop due to decrease in cash
and other liquid assets which caused fall from previously stable value of 1,13. Nevertheless, the ratio is
still above one so current assets can cover current liabilities. From broader perspective, such low ratio
could be problem in the long run and the company should implement measures to meet the industry
average which is considered as sound number for tobacco companies. The company could otherwise face
serious problems when unexpected events arrive.
The quick ratio (0,56), indicating how fast a business can meet its obligations with its liquid assets, dropped
significantly for the same reason as current ratio, but is only a little below industry average (0,68).
Cash ratio (0,28) shows us the trend of decreasing proportion of cash and increase in liabilities.
To conclude liquidity situation, basically all indicators are below industry average. The decrease in liquidity
measures with combination of efficiency measures may cause serious troubles in short horizon, if there
will be some unexpected expenses, which are not unusual for tobacco industry (e.g. anti-smoking laws,
lawsuits etc.). Hence, we should closely monitor the development of these figures.
Even though the debt ratio of BAT is quite high (77,78%), there is nothing to be concerned about as the
same is true for the whole tobacco industry (75,67%). On the other hand we can observe significant
increase throughout the period. Further increase may be sign of taking excessive leverage. Debt-to-equity
0.00
0.20
0.40
0.60
0.80
1.00
1.20
2011 2012 2013 2014
Inventory turnover Payables turnover Asset turnover

11. 10
ratio steadily grew over the same period of time. Actual value is 350,07%, which is 2,48 times the industry
average. The increase can be attributed to high dividends paid and repurchases of stocks during past years.
High interest coverage (8,50), computed as EBIT to interest expense, signalizes that the firm does not have
problems with paying interest on its debt. Moreover, this number is close to the mean of main
competitors.
As opposed to the liquidity situation, company seems really sound from the solvency perspective. Long
term position seems stable and debt ratio can be stabilized by decrease in dividends and stock
repurchases.
Profitability Measures
Return on assets is exactly at industry average (11,59%), but decreased significantly compared to previous
two years. This is caused by drop of sales and subsequent drop of net income.
Return on equity, signalizing returns on invested money of shareholders, increased significantly during
previous years but dropped in year 2014 as a consequence of lowered net income. Nevertheless, ROE is
still 51,15% - quite high value even for the high yielding tobacco industry with average of 41,19%.
High profit margin (22,3%) and EBITDA margin (39,02%) are certainly worth mentioning. They well above
the industry average (18,32% or 32,21% respectively) which indicates better cost control of the company
which can consequently generate larger profit on unit sale with comparison to competitors.
Price-earnings ratio (20,52) is slightly above the industry average (19,46) which indicates that investors do
not expect excess earnings growth in comparison with competitors.
0.00
0.20
0.40
0.60
0.80
1.00
1.20
2010 2011 2012 2013 2014
Current ratio Quick ratio Cash ratio
0.00%
50.00%
100.00%
150.00%
200.00%
250.00%
300.00%
350.00%
400.00%
2010 2011 2012 2013 2014
Debt ratio Debt to equity

12. 11
Price-to-book value skyrocketed during last five years. At the end of 2014, P/B was 11,63 which is almost
3 times the industry average. This value is at the same time close to the company’s maximum P/B.
Regarding profitability, company is doing pretty well, especially when we account for above-average
margins and ROE. Moreover, all time trends show quite stable and subtle positive development (except
the year 2014).
Dividend
The company has very high dividend payout (88,62%) with almost 20% increase in 2014. Average payout
for last 5 years was 77,12%. In absolute terms, net dividend attributed to majority shareholders accounted
for £ 2,712 bn. This significant payout ratio increase was probably caused by the decrease of net income
and the effort of the company to keep approximately 4% dividend yield. Even though BAT has no dividend
policy, trend to bring above-average 4% dividend yields is obvious.
With regard to solvency measures analysis above, pressure on keeping strong dividend yield growth can
potentially lead to troubles if net income will not significantly improve.
Year 2010 2011 2012 2013 2014
Dividend per share 1,14 1,27 1,35 1,42 1,48
dividend payout 78,62% 80,89% 68,18% 69,27% 88,62%
Dividend yield 5,10% 4,81% 4,24% 4,17% 4,32%
Dividend growth 11,40% 6,30% 5,19% 4,23%
0.00%
10.00%
20.00%
30.00%
40.00%
50.00%
60.00%
2011 2012 2013 2014
ROA ROE
0.00%
10.00%
20.00%
30.00%
40.00%
50.00%
2010 2011 2012 2013 2014
Profit margin EBITDA margin

13. 12
Sensitivity Analysis
In our discounted dividend model, three variables play key role in assessing the share price as they
determine the cost of equity. These are Risk free rate, Market risk premium and Beta parameter. As we
are aware of importance of these parameters, we selected and looked for them in the respectable
publications, e.g. in publication of Professor Aswath Damodaran.
In our sensitivity analysis in enclosed Excel file, we examined the changes of two parameters when third
was held constant. The analysis shows lower sensitivity to changes in the parameter beta compared to the
other two parameters. We have observed that decrease in beta results in larger increase in stock value
than decrease of value in case of increase of beta. From these three parameters the predicted price of
share is most sensitive to changes in market risk premium which does not present too of a trouble for us
because this parameter hasn’t changed for more than a few per mille in past months and therefore
potential error in estimate of this parameter wouldn’t have much impact on our conclusion.
The effect of change in sales growth on predicted value of share is considerable as we can see from our
scenario summary. Nevertheless, even in the worst case scenario the market price of stock is only slightly
higher than the predicted value. We can see that the model is quite robust in a sense that even if we allow
for quite decent changes of our parameters, it still supports our hypotheses that the stock on the market
is undervalued.
SALES GROWTH SCENARIO SUMMARY
high mid high base mid low low
2015 0,00% -3,00% -5,00% -7,00% -8,00%
2016 1,00% -2,00% -3,50% -4,00% -8,00%
2017 3,00% 0,00% -2,00% -3,00% -8,00%
Value of share 55,63865 49,36326 45,74713 43,68086 37,42227
Forecast
Sales Growth
Forecasting growth of sales is a key point in our valuation project. BAT’s sales have been stagnating
in recent years and in 2014 even dropped by 8.45%. The reason behind this are tightening regulations
causing losses in sales in North America and Europe which is currently only partially offset by growing sales
in emerging markets in Africa and South America. Following this trend we believe BAT will be incurring

14. 13
further losses in sales in upcoming years which however will slowly turn into slow growth due to
opportunities described in SWOT analysis (e.g. project Vype) and converge in horizon to growth of 1.83%
which is considered to be an optimal annual speed of growth of sales in tobacco industry.
Profit Margin after Tax
In following years we believe BAT will keep its high profit margin which is above industry average
around 25% as BAT will hold to their strong and stable market position.
Asset Turnover
Similarly to PM we believe this indicator won’t experience any substantial changes in upcoming
years and will remain quite stable at 0.54.
Financial Leverage
As BAT will be making effort to keep their dividends at high level, the financial leverage will stick
to its current trend and be increasing in next 3 years. In horizon this ratio should at least lower to 1.53
because too high financial leverage will not be optimal for BAT’s long-run sustainable position.
Net Operating Assets
To forecast Net operating assets we firstly obtained the ratios NOA/Assets, NOA/Operating
income (after tax) from historical data and then averaged the values of NOA implied by these ratios in
order to implement the future development of both Assets and Operating income to our Net operating
assets forecast.
Return on Financial Assets, Borrowing Costs
Return on financial assets appeared to be quite stable throughout the monitored period and we
have no reason to believe it will change in the future since BAT is not heavily involved in any speculative
investment activities. Financial income makes only a small part of the company’s overall income. When
forecasting borrowing costs we took into account the forecasted development of financial leverage as this
indicator will certainly influence BAT’s borrowing costs.
Financial Liabilities/Net Financial Liabilities
Similarly to Financial leverage, FL/NFL ratio will stick to its current trend in upcoming years and
converge to 1.68 in the horizon.

15. 14
Effective Tax Rate
Considering threats for BAT described in our SWOT analysis (growing health awareness,
governments passing further regulations) we believe effective tax rate will be slightly increasing in the
future converging to 35% in the horizon.
Valuation
For our valuation model purposes we have used following assumptions:
Because have been calculating with pounds in our valuation project, we have decided to use a yield on 30
year UK gilt as a currency consistent proxy for a risk-free rate. (Risk free rate: 2.39%)
As a market risk premium we have used a figure reported by well-known valuation expert Aswath
Damodaran in April 2015. (Market risk premium: 5.86%)
For beta we have used a figure reported on Reuters at the time our project was done. (𝛽: 0,88)
For the valuation we have used the dividend discount model. The goal of DDM is to find the
intrinsic value of a share through discounting predicted future dividends.
To find out the cost of equity (required return) used in discounting we have used CAPM.
𝑅𝑒𝑞𝑢𝑖𝑟𝑒𝑑 𝑟𝑒𝑡𝑢𝑟𝑛 = 𝑅𝑖𝑠𝑘 𝑓𝑟𝑒𝑒 𝑟𝑎𝑡𝑒 + 𝛽 ∗ 𝑀𝑎𝑟𝑘𝑒𝑡 𝑟𝑖𝑠𝑘 𝑝𝑟𝑒𝑚𝑖𝑢𝑚
Our DDM model implies the value of share is £ 45.75 which is around 22% above actual share
price. From this we can conclude the share with the price for which it is currently being traded is
undervalued.
Work Cited
Since the prevailing task of this paper was of a quantitative rather than historical or reference based
character, it will come as no surprise, that the main source of data were the official and/or modified
versions of the subject’s financial statements. However, for entirety, let us now include several works,
which served us while examining the company’s background and while putting it in the context of the
overall industry:

16. 15
William Barnett. The Global Tobacco Industry
Katsy Douangvichit, Nate Evett, Rajani Meka, Tom Wang. Philip Morris International
http://www.bat.com/group/
Robehmed, N. E-cigarette Sales Surpass $1 Billion As Big Tobacco Moves In, Forbes,
http://www.forbes.com/sites/natalierobehmed/2013/09/17/e-cigarette-sales-surpass-1-billion-as-big-
tobacco-moves-in/
Alan Kerstetter. ACCTG 404, Tobacco Industry Analysis
Tobacco and manufactured tobacco substitutes, UK Trade Tariffs, www.gov.uk/trade-tariff/commodities/