Morningstar has initiated coverage of British American Tobacco (BATS) with a BBB+ issuer rating, which reflects our assessment of the firm's wide economic moat, leadership position in many of its markets, and strong brand equity of its products. British American is geographically diverse, with a strong presence in Western Europe, Latin America, the Middle East, and Asia. It claimed around 13% of the market outside the United States in 2009, led by its Pall Mall, Kent, Dunhill, and Lucky Strike brands. Only a small proportion of the firm's earnings are derived in the mature markets of Britain and the US. Some overseas markets, particularly Africa, Eastern Europe, and parts of Asia, offer growth opportunities for British American because they have growing populations of young adults and looser restrictions on tobacco marketing. We estimate there will be 1.4 billion smokers globally by 2020, up from 1.3 billion today, even if the percentage of the population that smokes declines 1% annually. British American's global footprint means the firm is well positioned to capture these trends.
British American has slightly less leverage than its competitors, and its credit metrics are sound. The firm generates solid free cash flow, which we forecast to amount to 21% of revenue on average over the next 10 years. Free cash flow should cover debt and debtlike commitments almost 200% over the next five years, allowing the firm to comfortably meet its obligations. In fact, we believe the firm will have excess cash flow with which to make acquisitions, increase the dividend, or repurchase shares. Local cigarette brands play an important role in the portfolios of tobacco manufacturers because tastes and preferences vary from market to market; given the expansion opportunities that exist in emerging economies, we expect the firm will make bolt-on acquisitions in growth markets.
