Right now I’m looking at some of the most popular companies in the FTSE 100 to try and establish whether or not they have the potential to push profits up to levels not seen in the last few years.
Today I’m looking at British American Tobacco (LSE: BATS) (NYSE: BTI.US) to ascertain if it can make £5bn in profit.
Have we been here before?
A great place to start assessing whether or not British American can make £5bn in profit is to look at the company’s historic performance. Unfortunately, British American has never been able to make £5bn in profit but it would appear that the company is well positioned to do so.
In particular, thanks to gradual price increases and a strong performance from its key, ‘growth brands’, British America’s profit has ticked slowly higher over the past decade and seems to be set to continue. Indeed, even though the number of smoker worldwide is in terminal decline, the volume of cigarettes shipped by British American is only declining at a steady 3% to 4% per year.
However, while the overall volume of cigarettes shipped by British American is falling, sales of the company’s growth brands and fine cut tobacco continue to rise. Specifically, in the nine months to September last year, the volume of fine cut tobacco shipped by British American increased by 3.3% and the volume of cigarettes shipped in the company’s growth portfolio increased by 1.9%.
But what about the future?
The biggest threat facing British American is the declining number of smokers worldwide and rising excise taxes. But British American’s management sees rising excise taxes as an opportunity, allowing the company to offset the falling volume of cigarettes sold.
You see, British American has found that it can increase its own prices at the same time as excise taxes go up and consumers are unlikely to notice. As a result, rather than making less profit, British American expects that its profit margin will expand 0.5% to 1% every year thanks to rising taxes and sneaky price increases. Further, the company is working on higher margin products such as slim and faster burning cigarettes.
Moreover, British American is the worlds most geographically diverse tobacco company and sales growth in developing nations is more than offsetting sliding cigarette sales in the developed world.
With all these factors working in favour for the company, City analysts expect British American to report a pre-tax profit of £5.9bn for 2014, followed by £6.3bn for the year after — impressive for a company with falling sales.
Foolish summary
So overall, I feel that British American can make £5bn profit.
