Michael Burry, an investor best known for his “big short” during the Great Financial Crisis, has a hidden holding. British American Tobacco (LON:BATS) (NYSE:BTI) is Burry’s largest known stock holding, with a reported value of $11.2 million, according to filings with UK regulatory authorities. I’m also bullish on British American Tobacco, which I believe is becoming a better company from an ESG perspective and trades at an extraordinarily favorable valuation.
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Michael Burry’s Largest Holdings
Michael Burry’s five largest holdings, in order, are British American Tobacco, JD.com (NASDAQ:JD), Alibaba (NYSE:BABA), HCA Healthcare (NYSE:HCA), and Citigroup (NYSE:C). I own two of these stocks myself — British American Tobacco and Citigroup.
My investment strategy aligns with Burry’s, to an extent, because I’m a value investor who looks to exploit pessimism. I often buy unloved stocks with strong fundamentals. This seems to be the case with British American Tobacco.
Why British American Tobacco Is Unloved
I suspect two things are going on with British American Tobacco, causing it to trade at just 6.55x free cash flow: government intervention into the cigarette market (and British American Tobacco’s response) and the impact of ESG-friendly funds in Europe.
First, governments around the world continue to trample on cigarettes, with the UK attempting to prevent those born in 2009 or after from smoking cigarettes and the United States attempting to ban menthol cigarettes. I believe governments would be better suited putting warnings on the packaging of certain products like menthol cigarettes, which would allow consumers to make informed decisions. Cigarette volumes are on the decline in general due to a shift from combustibles to non-combustibles.
In response, British American Tobacco is slowly transitioning its product portfolio to non-combustible products like VUSE. This comes with profit margin anxiety, which may be overblown. For example, the gross profit margin for competitor Philip Morris (NYSE:PM), which has a significant non-combustibles business, has remained robust and is still on par with its 2018 levels.
Second, ESG-friendly investors typically don’t even consider investing in British American Tobacco. ESG has been a growing trend in recent years and seems to have driven a lot of money into technology stocks. Europe is especially ESG-conscious, which may be driving a valuation gap between British American Tobacco and U.S. peers. I like situations like this where there is a potential forced seller because it can create large discrepancies between the true economic value of a company and its market price.
The Valuation Gap Compared to U.S. Peers
If British American Tobacco traded at a similar price to free-cash-flow to its combined peers Altria (NYSE:MO) and Phillip Morris, the stock price would be 100% higher. There’s an enormous discrepancy here, which I believe is unjustified.
Let’s have a look. The combined trailing-12-months free cash flow of U.S.-domiciled companies Altria and Philip Morris International was $17.94 billion. Their combined market cap is around $235 billion, translating to a price-to-free cash flow multiple of 13.1x. Meanwhile, even if we adjust British American Tobacco’s free cash flow lower (as I did in an earlier piece), the company made $10.53 billion, giving it a price to free cash flow multiple of just 6.55x. That’s on its market cap of $69 billion.
British American Tobacco has less international exposure and a smaller non-combustibles business than Phillip Morris. However, it has more international exposure and a larger non-combustibles business than Altria, which operates primarily in the United States. Therefore, I believe if we combine the two, British American Tobacco should trade at a similar valuation. This could be why Michael Burry owns British American Tobacco rather than Altria or Phillip Morris.
Is BTI Stock a Buy, According to Analysts?
After a big sell-off, six of eight analysts covering British American Tobacco now give it a Buy rating, while two rate it a Hold, giving it a Strong Buy consensus rating. The average British American Tobacco stock price target is 2,907.14p, implying upside potential of 19.98%. Analyst price targets range from a low of 2,400p per share to a high of 3,450p per share.
The Bottom Line on BTI Stock
British American Tobacco is an unloved stock with strong fundamentals and a large price discrepancy. This may be why it is Michael Burry’s largest known position. I believe there has been some forced selling by ESG-friendly funds in Europe.
Consequently, if British American Tobacco traded at a free cash flow multiple similar to Altria and Phillip Morris International (combined), the stock price would be 100% higher. Lastly, Phillip Morris has demonstrated that its gross margin on non-combustible products can be robust. All in all, I think Burry’s position in BTI stock will be a highly profitable one.
