The British American Tobacco (LON:BATS) share price has dropped significantly recently. Back in mid-2022, shares in the tobacco giant were trading above the 3,500p mark. Today, however, they’re near 2,500p – almost 30% lower. So, why is the BATS share price falling at the moment? And will it recover in the future?
In my view, there are several factors behind the substantial fall in the tobacco company’s share price.
One is uncertainty in relation to the long-term outlook for the tobacco industry.
Today, tobacco companies are facing real headwinds as governments are continually introducing new regulations designed to stop people smoking.
For example, here in the UK, Prime Minister Rishi Sunak recently proposed a ban on cigarettes for younger generations.
It’s worth noting that BATS has been making moves to focus more on lower-risk products such as vapour products.
But these products are in the firing line too. For example, earlier this month, the US Food and Drug Administration (FDA) blocked the sale of six flavours of the company’s main vape brand, Vuse Alto, including menthol.
This high level of regulatory risk cannot be ignored.
A second factor is debt. At 30 June 2023, British American Tobacco had adjusted net debt of £37.3 billion on its balance sheet.
This is more of an issue in a ‘higher-for-longer’ interest rate environment. Going forward, interest payments on this debt could eat into profits and impact cash available for dividends.
A third factor behind the share price weakness is the strength of tech stocks. In recent years, tobacco stocks like BATS have tended to move in the opposite direction to tech stocks. For example, when tech stocks plummeted in 2022, tobacco stocks jumped.
This year, tech stocks have done really well as investors have focused on the long-term growth potential of industries such as artificial intelligence (AI), cloud computing, and digital advertising. This has led to flows out of the tobacco sector.
As for whether BATS shares will recover, it’s hard to know.
They do look undervalued right now. At present, British American Tobacco has a forward-looking price-to-earnings (P/E) ratio of just 6.5. That’s around half the average FTSE 100 P/E ratio. So, there is room for a valuation re-rating.
However, with so much uncertainty in relation to the long-term outlook, we may not see a re-rating any time soon.
Return to safety
Now, a technology sector crash could change things. If tech stocks were to experience another major meltdown, we may see investors gravitate towards old-economy stocks like BATS.
However, while tech stocks are doing well, I think BATS shares are going to struggle. Why invest in a company in a declining industry such as tobacco when you can invest in a company in a growing industry such as AI or cloud computing?
High dividend yield
It’s worth pointing out that BATS shares could still deliver solid returns even if the share price doesn’t rebound in the future. That’s because they currently offer a dividend yield of nearly 10%.
That said, if the share price was to continue falling from here (downtrends can last longer than expected), any gains from dividends could be wiped out by capital losses.
But, dividends are never guaranteed.