It was only six years ago that British American Tobacco (BTI -0.85%) spent a fortune to greatly expand its presence in the U.S. cigarette market. The 2017 acquisition of Reynolds cost the company $49.4 billion, half in cash and half in stock. British American Tobacco’s debt-heavy balance sheet is partially a result of this cigarette megadeal.
Reynolds brought with it a portfolio of popular brands, including Newport, Camel, and American Spirit. But with cigarette consumption in the U.S. in decline, those brands are worth far less today than what British American Tobacco paid in 2017. The company announced on Wednesday that it is taking a non-cash impairment charge of approximately $31 billion to reduce the carrying value of its acquired U.S. cigarette brands. Going even further, the company will begin amortizing the remaining value of those brands in 2024.
When one company acquires another, any amount above and beyond the net worth of the acquired company goes on the acquiree’s balance sheet as intangible assets. Some intangible assets are amortized from the start, reducing earnings. Goodwill, a class of intangible assets that isn’t amortized, must be written down when it becomes clear that its value hasn’t held up.
That’s what British American Tobacco is now doing. The value of those acquired U.S. cigarette brands has plunged in the wake of a declining U.S. market, a difficult economic environment, and the company’s general strategy of shifting toward non-combustibles. The company is seeing pressure on premium brands, a sign that its strategy of pushing up pricing is hitting its limit.
The impact on British American Tobacco’s results
This is a non-cash impairment charge, so it won’t affect the company’s cash flow at all. It will, however, affect the company’s net income, which is an accounting figure. When British American Tobacco reports its full 2023 results, that mega-write-down will plunge net income deep into negative territory.
In 2024 and beyond, net income will be reduced as the company amortizes the remaining value of those U.S. brands. These additional charges will also only affect net income, not cash flow. The company didn’t disclose the pace at which this amortization will occur, but the plan is to bring the carrying value of these acquired brands down to zero over time.
Excluding the write-down, British American Tobacco expects its adjusted earnings per share to grow by a mid-single-digit percentage in 2023. This adjusted figure gives investors a better idea of how the company is performing compared to the unadjusted figure, which will be deeply negative thanks to the write-down. In 2024 and beyond, adjusted earnings will likely exclude additional amortization charges as well.
The balance sheet will also be affected. The value of British American Tobacco’s assets will be reduced by this write-down, making the balance sheet look more precarious. The company is working on reducing its debt, with plans to bring its net debt down to about 2.5 times adjusted EBITDA. By the end of 2023, the company expects that ratio to hit about 2.7.
Slower growth for now
By 2026, British American Tobacco expects its revenue growth rate to rebound to a range of 3% to 5% and its adjusted profit from operations growth rate to reach a mid-single-digit percentage. However, given the challenges in the U.S. cigarette market and the investments the company is making in its non-combustible businesses, both metrics will fall short in 2024. British American Tobacco expects revenue and adjusted profit from operations to expand by low-single-digit percentages next year, excluding the impact of currency and divestitures.
The write-down doesn’t impact the company’s ability to pay its dividend because it doesn’t impact cash generation. But with British American Tobacco’s dividend yield now nearly 10%, it’s clear that investors are pessimistic that the dividend is sustainable. The dividend looks safe at the moment, but a worse-than-expected performance from the core cigarette business could change that in the years ahead.
British American Tobacco is going to look like a very different company a decade from now, with plans to boost non-combustible revenue to 50% of total revenue by 2035. But as evidenced by the massive write-down of its U.S. cigarette brands, the transition is not going to be smooth or painless for investors.
Timothy Green has positions in British American Tobacco P.l.c. The Motley Fool recommends British American Tobacco P.l.c. and recommends the following options: long January 2024 $40 calls on British American Tobacco P.l.c., long January 2026 $40 calls on British American Tobacco P.l.c., and short January 2026 $40 puts on British American Tobacco P.l.c. The Motley Fool has a disclosure policy.
