Company Quick10K Filing
British American Tobacco
20-F 2019-12-31 Filed 2020-03-26
20-F 2018-12-31 Filed 2019-03-15
20-F 2017-12-31 Filed 2018-03-15

BTI 20F Annual Report

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British American Tobacco Earnings 2017-12-31

Balance SheetIncome StatementCash Flow

20-F 1 d492188d20f.htm 20-F 20-F
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 20-F

 

 

(Mark One)    

REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934

OR

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended 31 December 2017

OR

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

OR

 

SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Date of event requiring this shell company report                     

For the transition period from                  to                 

Commission file number 001-38159

 

 

British American Tobacco p.l.c.

(Exact name of Registrant as specified in its charter)

 

 

    

(Translation of Registrant’s name into English)

England and Wales

(Jurisdiction of incorporation or organization)

Globe House, 4 Temple Place, London WC2R 2PG, United Kingdom

(Address of principal executive offices)

Paul McCrory, Company Secretary

Tel: +44 (0)20 7845 1000

Fax: +44 (0)20 7240 0555

Globe House, 4 Temple Place, London WC2R 2PG, United Kingdom

(Name, Telephone, E-mail and/or Facsimile number and Address of Company Contact Person)

Securities registered or to be registered pursuant to Section 12(b) of the Act.

 

Title of each class

 

Name of each exchange on which registered

American Depositary Shares (evidenced by American Depositary Receipts) each representing one Ordinary Share   New York Stock Exchange
Ordinary Shares, nominal value 25 pence per share  

New York Stock Exchange*

 

* Application made for registration purposes only, not for trading, and only in connection with the registration of the American Depositary Shares pursuant to the requirements of the Securities and Exchange Commission.

Securities registered or to be registered pursuant to Section 12(g) of the Act.

None

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act.

None

 

 

Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report.

2,456,278,414 Ordinary Shares

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    ☐  Yes    ☒  No

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.    ☐  Yes    ☒  No

Note – Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 from their obligations under those Sections.

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    ☒  Yes    ☐  No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    ☒  Yes      ☐  No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or an emerging growth company. See definition of “large accelerated filer,” accelerated filer,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer       

Accelerated filer

 

Non-accelerated filer

       Emerging growth company  

If an emerging growth company that prepares its financial statements in accordance with U.S. GAAP, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards† provided pursuant to Section 13(a) of the Exchange Act.  ☐

† The term “new or revised financial accounting standard” refers to any update issued by the Financial Accounting Standards Board to its Accounting Standards Codification after April 5, 2012.

Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:

 

U.S. GAAP  ☐   

International Financial Reporting Standards as issued by the International Accounting Standards Board  ☒

                 Other  ☐

If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow.    ☐  Item 17    ☐  Item  18

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    ☐  Yes    ☒  No

 

 

 


Table of Contents

LOGO

 

Transforming

Tobacco

Annual Report and Form 20-F 2017

 

 

LOGO


Table of Contents

 

 

 Contents 

 

    

 

Strategic Report

 

Overview     
Transforming Tobacco    01
Chairman’s introduction    07
Our strategic framework for transforming tobacco    08
Our year in numbers    10
Strategic management     
Chief Executive’s review    12
Finance Director’s overview    14
Global market overview    15
Our global business    16
Our business model    18
Delivering our strategy    20
Stakeholder engagement    30
Financial Review     
Financial performance summary    33
Income statement    34
Treasury and cash flow    38
Other    41
Regional review    42
Business environment     
Principal Group risk factors    48
Governance   
Directors’ Report     
Chairman’s introduction    55
Board of Directors    56
Management Board    58
Leadership and effectiveness    59
Board activities in 2017    60
Board effectiveness    62
Audit Committee    65
Nominations Committee    71
Remuneration Report    73
  
Financial Statements   
Group Financial Statements    100
Independent auditor’s report    100
Group companies and undertakings    199
  
Other Information   
Additional disclosures    215
Shareholder information    240

 

 

LOGO

British American Tobacco p.l.c. (No. 3407696) Annual Report 2017

This document constitutes the Annual Report and Accounts of British American Tobacco p.l.c. (the Company) and the British American Tobacco Group prepared in accordance with UK requirements and the Annual Report on Form 20-F prepared in accordance with the US Securities Exchange Act of 1934 (the Exchange Act) for the year ended 31 December 2017. Moreover, the information in this document may be updated or supplemented only for purposes of the Annual Report on Form 20-F at the time of filing with the SEC or later amended if necessary. Any such updates, supplements or amendments will also be denoted with a ‘»’ symbol. Insofar as this document constitutes the Annual Report and Accounts, it has been drawn up and is presented in accordance with, and reliance upon, applicable English company law and the liabilities of the Directors in connection with this report shall be subject to the limitations and restrictions provided by such law.

This document is made up of the Strategic Report, the Governance Report, the Financial Statements and Notes, and certain additional information. Our Strategic Report, pages 1 to 54, includes our vision and strategy, global market overview, business model, global performance, as well as our financial performance and principal group risk factors. The Strategic Report has been approved by the Board of Directors and signed on its behalf by Paul McCrory, Company Secretary. Our Governance Report, pages 55 to 99 contains detailed corporate governance information, our Committee reports and responsibility of Directors. The Directors’ Report on pages 55 to 72 (the Governance pages) and 215 to 262 (the Additional Disclosure and Shareholder Information pages) has been approved by the Board of Directors and signed on its behalf by Paul McCrory, Company Secretary. Our Financial Statements and Notes are on pages 100 to 198. The Other Information section commences on page 215.

This document provides alternative performance measures (APMs) which are not defined or specified under the requirements of International Financial Reporting Standards (IFRS). We believe these APMs provide readers with important additional information on our business. This year, we have included a Non-GAAP measures section on pages 218 to 222 which provides a comprehensive list of the APMs that we use, an explanation of how they are calculated, why we use them and a reconciliation to the most directly comparable IFRS measure where relevant.

BAT has shares listed on the London Stock Exchange (BATS) and the Johannesburg Stock Exchange (BTI), and, as American Depositary Shares (ADSs), on the New York Stock Exchange (BTI).

The Annual Report is published on www.bat.com. A printed copy is mailed to shareholders on the UK main register who have elected to receive it. Otherwise, shareholders are notified that the Annual Report is available on the website and will, at the time of that notification, receive a short Performance Summary (which sets out an overview of the Group’s performance, headline facts and figures and key dates in the Company’s financial calendar) and Proxy Form.

Specific local mailing and/or notification requirements will apply to shareholders on the South Africa branch register.

References in this publication to ‘British American Tobacco’, ‘BAT’, ‘Group’, ‘we’, ‘us’ and ‘our’ when denoting opinion refer to British American Tobacco p.l.c. and when denoting tobacco business activity refer to British American Tobacco Group operating companies, collectively or individually as the case may be.

The material in this Annual Report is provided for the purpose of giving information about the Company to investors only and is not intended for general consumers. The Company, its directors, employees, agents or advisers do not accept or assume responsibility to any other person to whom this material is shown or into whose hands it may come and any such responsibility or liability is expressly disclaimed. The material in this Annual Report is not provided for product advertising, promotional or marketing purposes. This material does not constitute and should not be construed as constituting an offer to sell, or a solicitation of an offer to buy, any of our products. Our products are sold only in compliance with the laws of the particular jurisdictions in which they are sold.

References in this document to information on websites, including the web addresses of BAT and Reynolds American Inc. (Reynolds American or RAI), have been included as inactive textual references only. These websites and the information contained therein or connected thereto are not intended to be incorporated into or to form part of the Annual Report and Form 20-F.

Cautionary statement

This document contains forward-looking statements. For our full cautionary statement, please see page 239.

 

 

 
www.bat.com/reporting      www.bat.com/investors      BAT IR app

 


Table of Contents
                       
 Overview         

Strategic Report

 

       

Governance

 

       

Financial Statements    

 

       

Other Information

 

 

  British American Tobacco (BAT) is one of the world’s leading consumer goods companies, with brands sold around the globe. We employ over 55,000 people globally, partner with over 90,000 farmers and have factories in 42 countries, with offices in even more.

 

 

Transforming

Tobacco

 

LOGO  

At BAT, we have been satisfying consumers, delivering shareholder value and creating valued employment for over a century.

 

However, we are entering the most dynamic period of change our industry has ever encountered.

 

An unprecedented confluence of technology, societal change and public health awareness has created a unique opportunity: the opportunity to make a substantial leap forward in our long-held ambition to provide our consumers with lower risk tobacco and nicotine choices.

 

 

 

Our acquisition of Reynolds American Inc. (Reynolds American or RAI), which has transformed both the scale and geographic reach of our business and our portfolio of potentially reduced-risk products, now positions us perfectly to capitalise on this ambition.

 

We call this ambition ‘transforming tobacco’ and we are fully committed to leading this transformation.

 

BAT Annual Report and Form 20-F 2017   01


Table of Contents

 

 Overview 

 

                                  

 

 

The advent of new and better consumer technologies meant that, in 2012, we articulated a new vision – to be the best at satisfying consumer moments in “tobacco and beyond” – with consumers right at the centre of our strategy.

 

We were clear then, as we are now, that we would build our business based on outstanding products, informed consumer choice and a drive towards a reduced-risk portfolio. More choice, more innovation, less risk.

 

Leading change

to  shape the future

LOGO  

 

It is widely accepted that most of the harm associated with tobacco is caused by inhaling the smoke produced by the combustion of tobacco. That is why we are dedicated to the development and sale of a range of potentially reduced-risk products that provide the enjoyment of smoking without burning tobacco.

 

These potentially reduced-risk products include Next Generation Products (NGPs), comprising vapour and tobacco heating products (THPs), as well as oral tobacco and nicotine products such as snus and moist snuff.

  

 

Since 2012, together with Reynolds American, we have invested approximately US$2.5 billion in the growth of our range of NGPs. We have also significantly increased the size of our existing oral tobacco business with the addition of more snus and moist snuff brands in the US.

 

Our commitment to leading and accelerating this transformation is also demonstrated by the changes we are making in how we run our business – including our NGP activities being integrated into the heart of the Company across all functions and across all geographies.

 

02   BAT Annual Report and Form 20-F 2017


Table of Contents
    

 

Strategic Report

 

       

 

Governance

 

       

 

Financial Statements

 

       

 

Other Information

 

 

 

         

While we cannot be certain whether all smokers will switch to potentially reduced-risk products, we are committed to making a range of high-quality, innovative products as widely available as practicable to address the varied preferences of our consumers.

 

We believe that by doing this, and working with regulators to establish supportive regulatory regimes, many millions of smokers will increasingly make the choice to switch.

...supported by

proactive external

engagement

 

                                                                                          This transformation is larger than just BAT. Lasting change will only be achieved by a combination of the commitment and product investment from companies like BAT and the support of regulators through the establishment of sensible regulation promoting a spectrum of potentially reduced-risk products.   

We also need the objective and balanced support of public health bodies, politicians, media and academics in driving informed choice and consumer trust.

 

If we can all work successfully together we can drive a triple win. Our consumers will have a range of potentially safer choices; society could benefit from real progress in tobacco harm reduction; and our shareholders will own an even more sustainable and profitable business.

LOGO

 

BAT Annual Report and Form 20-F 2017   03


Table of Contents

 

 Overview 

 

                                  

 

 

LOGO    The investments that we have made are now delivering real, tangible results. Thanks to our commitment, we are now able to provide an unrivalled suite of potentially less harmful products that can address the many and varied preferences of today’s more demanding consumers.

Inspiring

products

 

LOGO

  

 

 

 

Today, we have industry-leading products in vapour; in tobacco heating products; in oral tobacco (including snus and moist snuff); and in our tobacco-free nicotine pouches. This is just a beginning. We aim for far more.

 

These smokeless products offer genuine choices to consumers searching for alternatives to traditional cigarettes.

 

LOGO

  

LOGO

 

This investment has been driven by our firmly held belief that our consumers are not all the same and so will need a range of different products to meet their varied and constantly evolving preferences.

 

However, this is just the start. To lead this transformation we must win the technology race, so our R&D investment, led by hundreds of scientists across the world, is predominantly focused on developing our pipeline of potentially reduced-risk products.

 

04   BAT Annual Report and Form 20-F 2017


Table of Contents

LOGO

 

BAT Annual Report and Form 20-F 2017   05


Table of Contents

 

 Overview 

 

                                  

 

 

      

All of the progress we have made to date gives us confidence to set clear ambitions for our future.

 

By the end of 2018 our objective is to generate over £1 billion revenue from NGPs and by 2022 to have increased that figure fivefold to £5 billion.

 

Taken together with the growing revenue from our oral tobacco business, we fully expect that by 2030 a very significant percentage of Group revenue will be generated by our suite of potentially reduced-risk products.

This is only

the beginning

 

£1bn

In 2018, our aim is to double our NGP revenue to £1 billion.

£5bn

By 2022, our aim is to deliver £5 billion in NGP revenue.

These aims will not be easy to reach, but, with a combination of commitment and investment, we believe they are achievable.

However, even with these ambitious objectives, it is clear that conventional cigarettes will remain a key part of our business for many years to come and will continue to provide a vital source of investment for our NGPs.

We often get asked why we don’t just stop selling cigarettes? In short, we don’t believe this would be commercially sensible or practical: the ongoing consumer demand for these products would either transfer straight to our competitors or, more worryingly, the black market and in many markets there are still real regulatory obstacles to launching NGPs.

That is why alongside our commitment to the transformation of our business, we also remain fully committed to our combustible tobacco business during this transformation.

 

LOGO

 

06   BAT Annual Report and Form 20-F 2017


Table of Contents
    

 

Strategic Report

 

       

 

Governance

 

       

 

Financial Statements

 

       

 

Other Information

 

 

Chairman’s introduction

 

 

LOGO   

“During what has been a

landmark year in the history

of the Group, we have continued

to deliver for shareholders”

 

Richard Burrows

Chairman

 

A strong set of results

Welcome to our combined Annual Report and Form 20-F for 2017. During what has been a landmark year in the history of the Group, we have continued to deliver for shareholders and I am very pleased to report a strong set of results, with market share, revenue and profit all growing.

In a year when the Group became truly global following the acquisition of Reynolds American, we are now in an even better position to shape the future of our industry during a period of profound change which can deliver benefits for consumers, society and investors alike.

Acquisition of Reynolds American

The deal to acquire Reynolds American not only creates a stronger, global tobacco and Next Generation Products business, committed to delivering sustained long-term profit growth and returns, it also enables us to leverage the complementary skills from our new, enlarged workforce. The Group now has a balanced presence across emerging markets and developed markets, including the attractive US market.

We are committed to transforming tobacco by using our enhanced resources following the acquisition to deliver even greater choice for our adult consumers – across the combustible portfolio as well as those potentially reduced-risk products like vapour, heated and oral tobacco.

Additionally, increased access to a significant proportion of Group cash flows provides further support to the Company’s continued commitment to a dividend payout ratio of at least 65%. We will also retain a strong financial profile, with the Group targeting a solid investment grade credit rating through progressive deleveraging.

Quarterly dividends

The dividend in respect of 2017 is 195.2p, being an increase over 2016 of 15.2% (2016: 169.4p).

As announced in April 2017, the Group has moved to quarterly dividends with effect from 1 January 2018. In order to effect the transition to quarterly dividends, we committed to ensuring shareholders would receive an equivalent cash amount in 2018 under the quarterly dividend approach as they would have done under the previous methodology.

As part of this process, a second interim dividend of 43.6p (equivalent to 25% of the cash dividend paid in 2017) was declared in December 2017 and paid in February 2018. The Board has declared an interim dividend of 195.2p per ordinary share, payable in four equal dividend payments of 48.8p per ordinary share, to shareholders registered on the UK main register or the South Africa branch register and to ADS holders, each on the applicable record dates. The dividends receivable by ADS holders in US dollars will be calculated based on the exchange rate on the applicable payment dates.

Further information on dividends can be found on page 37 of the Financial Review and page 241 in the Shareholder information section.

Board changes

We were very pleased to welcome Lionel Nowell, III, Holly Keller Koeppel and Luc Jobin who joined our Board as Non-Executive Directors from Reynolds American and I look forward to the insights that they will provide to the Board.

I would like to thank Ann Godbehere and Dr Pedro Malan, who will be retiring from the Board at the conclusion of the forthcoming AGM on 25 April 2018. Ms Godbehere has served as a Non-Executive Director since October 2011 and Dr Malan has served as a Non-Executive Director since February 2015.

Our approach to governance

Good governance has long been a key priority for the Group. Continuing to meet all our obligations under the various frameworks with which we are bound by is not only about compliance with the law, but also about ensuring that the Group is delivering results with integrity.

With the Reynolds American acquisition now complete, not only are we a stronger business, but we are also subject to further requirements under US law. Whether through increased reporting transparency under the Sarbanes-Oxley Act, or through the Foreign Corrupt Practices Act, we have new legislation with which we have to comply.

As a result of these new requirements, our Annual Report encompasses our obligations under the UK (as required by the Companies Act, the FCA Handbook, the Financial Reporting Council and London Stock Exchange Rules), South Africa (as required by the Johannesburg Stock Exchange) and US (as required by US securities laws, the Securities and Exchange Commission rules and the New York Stock Exchange) regulations. All of these requirements have been brought into this consolidated Annual Report and Form 20-F.

Outlook

This is a very exciting time for the tobacco and nicotine industry, and for the Group in particular. The advent of new, potentially reduced-risk products that can satisfy consumers means there are new growth opportunities for the business.

While challenging conditions persist, the Group’s approach of placing the consumer at the centre of its strategy, along with a multi-category portfolio of products designed to address their varying preferences, ensures that our business is in an even stronger position to deliver long-term, sustainable growth.

Richard Burrows

Chairman

 

 

   
BAT Annual Report and Form 20-F 2017   07


Table of Contents

 

 Overview 

 

                                  

 

Our strategic framework

for transforming tobacco

 

Our strategy remains as relevant today to drive our transforming tobacco ambition as it was when it was first rolled out in 2012. It enables us to deliver growth today while driving the investment required to deliver our transformational agenda.

 

Our vision remains clear: while combustible tobacco products will remain at the core of our business for some time to come, we understand that long-term sustainability will be delivered by our transforming tobacco ambition.

  

 

 

LOGO

 

   
08   BAT Annual Report and Form 20-F 2017


Table of Contents
    

 

Strategic Report

 

       

 

Governance

 

       

 

Financial Statements

 

       

 

Other Information

 

 

 

 

Our vision

World’s best at satisfying

consumer moments in

tobacco and beyond.

Our consumers are at the core of everything we do and our success depends on addressing their preferences, concerns and behaviours.

We know that these are fragmenting and evolving at an unprecedented pace, and consequently, we are focusing on providing a range of tobacco and nicotine products across the risk spectrum. In addition, we are clear that to win in this space we need to understand our consumers’ preferences and further invest in a pipeline of ever evolving innovations.

 

Our mission

Delivering our commitments

to society, while championing

informed consumer choice.

We have long known that, as a major international business, we have a responsibility to address societal issues with our tobacco products, and that, as our business continues to grow, so does our influence and the responsibility that comes with it.

We are also clear that we have a duty to our shareholders to ensure we continue to deliver today and invest for a sustainable future and to our consumers to provide, in addition to our combustible products, a range of potentially reduced-risk products such as NGPs and oral tobacco products.

Our transforming tobacco ambition, with its core objective of providing consumers with more choice, more innovation and less risk will allow us to: satisfy these consumers; address societal concerns at large through the growth of multiple categories of potentially reduced-risk tobacco and nicotine products; and provide a sustainable, profitable future for our shareholders.

 

Strategic focus areas

Our four key focus areas remain fundamental to our strategy as we focus on our transforming tobacco ambition.

 

LOGO     Growth   page 20

Constantly developing our portfolio of potentially reduced-risk products and new technologies while continuing to drive revenue growth from our traditional combustible products.

 

 
LOGO     Productivity   page 23

Effectively deploying resources between product categories and managing our cost base to release funds for investment.

 

 
LOGO     Winning organisation   page 25

Ensuring we have great people with the right skill sets in the right teams to drive the transformation of our business.

 

 
LOGO     Sustainability   page 27

Ensuring a sustainable business that meets the expectations of all our various stakeholders.

 

 
LOGO     Read about our industry   page 15
 

 

 

Guiding Principles

Our Guiding Principles provide clarity about what we stand for.

They form the core of our culture and guide how we deliver our strategy.

 

Enterprising

spirit

We value enterprise from all of our employees across the world, giving us a great breadth of ideas and viewpoints to enhance the way we do business. We have the confidence to passionately pursue growth and new opportunities while accepting the considered entrepreneurial risk that comes with it. We are bold and strive to overcome challenges. This is the cornerstone of our success.

Freedom through

responsibility

We give our people the freedom to operate in their local environment, providing them with the benefits of our scale but also the ability to succeed locally. We always strive to do the right thing, exercising our responsibility to society and other stakeholders. We use our freedom to take decisions and act in the best interest of consumers.

Open

minded

Our corporate culture is a great strength of the business and one of the reasons we have been, and will continue to be, successful. We are forward-looking and anticipate consumer preferences, winning with innovative, high-quality products. We listen to, and genuinely consider, other perspectives and changing social expectations. We are open to new ways of doing things.

Strength from

diversity

Our management population comprises people from over 140 nations, giving us unique insights into local markets and enhancing our ability to compete across the world. We respect and celebrate each other’s differences and enjoy working together. We harness diversity – of our people, cultures, viewpoints, brands, markets and ideas – to strengthen our business. We value what makes each of us unique.

 

 

   
BAT Annual Report and Form 20-F 2017   09


Table of Contents

 

 Overview 

 

                                  

 

Our year in numbers

 

Our progress: The Group delivered another

year of growth across our key metrics.

  LOGO
 
 

 

 

Group cigarette (and tobacco heating

products – THP) volume

 

 

LOGO

 

 

Group market share of key markets

 

LOGO

 

 

 

Global Drive Brands (GDBs)
cigarette and THP volume

 

LOGO

 

 

GDB overall market share (ex US) growth

 

LOGO

 

 

Global Drive and Key Strategic Brands
(GDSBs) total cigarettes and THP volume

 

LOGO

  

 

Revenue

(£m)

 

LOGO

 

 

Change in adjusted2 revenue
at constant rates1 (%)

 

LOGO

 

 

Total dividends per share
(p)

 

 

LOGO

  

 

Profit from operations

(£m)

 

LOGO

 

 

Change in adjusted2 profit from
operations at constant rates1 (%)

 

LOGO

 

 

Total shareholder return (TSR) of the
FMCG group – 1 January 2015
to 31 December 2017 (%)

The FMCG group comparison is based on three months’ average values

 

LOGO

 

   
10   BAT Annual Report and Form 20-F 2017


Table of Contents
    

 

Strategic Report

 

       

 

Governance

 

       

 

Financial Statements

 

       

 

Other Information

 

 

 

Notes: To supplement our results of operations presented in accordance with IFRS, the information presented also includes several non-GAAP measures used by management to monitor the Group’s performance. See the section Non-GAAP Measures beginning on page 218 for information on these non-GAAP measures, including their definitions and reconciliations to the most directly comparable IFRS measure, where applicable. Certain of our measures are presented based on constant rates of exchange, on an adjusted basis and on an organic basis.

 

1. Where measures are presented ‘at constant rates’, the measures are calculated based on a retranslation, at the prior year’s exchange rates, of the current year results of the Group and, where applicable, its segments. See pages 41 and 224 for the major foreign exchange rates used for Group reporting.  

 

2. Where measures are presented as ‘adjusted’, they are presented before the impact of adjusting items. Adjusting items represent certain items of income and expense which the Group considers distinctive based on their size, nature or incidence.  

 

3. Where measures are presented as ‘organic’ or ‘org’, they are presented before the impact of the contribution of businesses acquired during 2017, including Reynolds American, Bulgartabac, Winnington and Fabrika Duhana Sarajevo.  

 

 

Diluted earnings per share (EPS)
(p)

 

LOGO

  

 

Net cash generated from operating
activities (£m)

 

LOGO

  

 

Operating margin
(%)

 

LOGO

 

Change in adjusted2 diluted EPS
(%)

 

LOGO

     

 

Adjusted2 operating margin
(%)

 

LOGO

 

Change in adjusted2 diluted EPS
at constant rates1 (%)

 

LOGO

  

 

Cash conversion
(%)

 

LOGO

  

 

   
BAT Annual Report and Form 20-F 2017   11


Table of Contents

 

 Strategic Management 

 

                                  

 

Chief Executive’s review

 

 

LOGO

 

                        “Following our acquisition
of RAI, and the progress
we are making 
with NGPs,
we can now accelerate
our ambition to
transform tobacco

 

   Nicandro Durante
   Chief Executive

 

 

   
12   BAT Annual Report and Form 20-F 2017


Table of Contents
    

 

Strategic Report

 

       

 

Governance

 

       

 

Financial Statements

 

       

 

Other Information

 

 

 

Leading the industry

The Group delivered another set of strong financial results in 2017, despite a challenging trading environment. Following the transformational deal in July 2017, these results benefit from the acquisition of Reynolds American Inc. (RAI) while also demonstrating the strength of the organic business.

The Group has delivered outstanding returns to shareholders for many years. We recognise that the tobacco and nicotine industry has entered a dynamic period of change. Increased public health awareness, new societal attitudes and rapid developments in new technologies have all combined to create a unique opportunity to accelerate the delivery of our long-held ambition to provide our consumers with less risky tobacco and nicotine choices.

Since 2012, together with RAI, we have invested approximately US$2.5 billion in the growth of our Next Generation Product (NGP) business – comprising vapour and tobacco heating products (THPs). Following the acquisition of RAI, not only have we become the world’s leading vapour company, we have also significantly increased the size of our existing oral tobacco and nicotine business with the addition of leading snus and moist snuff brands in the US. Collectively, we refer to these products as our potentially reduced-risk products.

Our investments are now coming to fruition and, recognising that not all consumers are the same, we now have an unrivalled range of exciting and innovative products across the potentially reduced-risk categories – including, vapour, THPs, oral tobacco, tobacco-free nicotine pouches and moist snuff. With the increased size and scale coming from RAI, we are clear leaders in the potentially reduced-risk product space and we are confident of leading the NGP category. This year we generated NGP revenue of £397 million. On a full year basis, including the contribution from RAI, this would have been approximately £500 million and we expect this to double in 2018 to £1 billion, rising to more than £5 billion in 2022.

New Strategic Portfolio of brands

In light of the evolution of the business, with the addition of leading brands in the US, as well as the growing importance and progress of our potentially reduced-risk products, we have taken the opportunity to establish a new portfolio of priority brands – which we will in future refer to as our Strategic Portfolio.

This Strategic Portfolio comprises our existing GDBs, combined with RAI’s Strategic Brands (Camel, Newport and Natural American Spirit). Also included is our portfolio of potentially reduced-risk products, including our key oral tobacco brands and NGP brands in vapour and THP. Further details can be found on pages 16 and 17.

 

From 2018, the Group will introduce a new metric called Revenue Growth of our Strategic Portfolio, replacing the Global Drive Brand (GDB) & Key Strategic Brand (KSB) volume growth metric. To provide the comparator against which 2018 will be measured, Revenue of our Strategic Portfolio in 2017 would have been £16,711 million assuming we had consolidated RAI for a full 12 months and after recognising the impact of implementing the new accounting requirements of IFRS 15.

Strong results across our portfolio of products

Notwithstanding the good progress we are making with our potentially reduced-risk products, combustible cigarette products remain at the core of our business – delivering growth today and providing the funds required for investing in the future. I am therefore pleased that 2017 saw the Group yet again deliver another good performance.

The Group’s cigarette market share in its Key Markets continued to grow strongly (up 40 bps). This was powered by another excellent performance by our GDBs, which grew 110 bps (ex US) and now account for more than 50% of Group cigarette and THP volume outside the US. Over the year, market share in the US also grew strongly and was up 20 bps, with the RAI Strategic Brands growing 40 bps.

Total Group cigarette and THP volume grew 3.2% to 686 billion, or on an organic basis fell 2.6%, outperforming the industry, which was estimated to have declined by around 3.5%.

In 2017, we also made excellent progress with our NGP business. Our flagship THP, glo, first launched in Japan in December 2016, reached 3.6% market share by the end of 2017 – having been rolled out nationally from October 2017. Since then, 50% of the overall category growth in Japan has been from glo – demonstrating its strong consumer appeal in a very short period. Good initial progress is also being made in our other launch markets of South Korea, Russia, Canada, Romania and Switzerland.

In the vapour category, Vype is now present in nine markets and we remain the market leader in the UK, with Vype and Ten Motives combined delivering around 40% share of measured retail in December 2017. We also lead the vapour category in Poland. In the US, the Vuse range of products continues to have a significant presence in the market. We see the rapidly developing vapour category, as a whole, contributing significantly to our long-term growth ambitions in NGPs.

The Group’s financial performance was positively impacted by the accounting for the acquisition of RAI and the subsequent US tax reforms. These drove diluted earnings per share up by over 600% to 1,830.0p.

 

However, while trading conditions remain challenging in a number of markets, including ad hoc excise increases and increasing illicit consumption, 2017 again saw the Group deliver on its high single-digit earnings growth commitment on an adjusted basis, increasing adjusted diluted earnings per share by 14.9% to 284.4p, or 9.9% at constant rates of exchange.

Group structural changes

Having the right organisational structure will set us up for continued long-term success as a truly global multi-category business, with NGPs embedded at the core.

With the NGP business set for significant expansion and growth, we decided to integrate it into our existing geographic structure. This has enabled us to begin fully leveraging the scale and expertise of the whole Group to drive growth in an area that is fast becoming a key part of our core business.

In order to address the key opportunities and challenges we face going forward, we recognised the need to ensure the combustible business operates even more efficiently than ever before. To achieve this, we created three new regions – Americas and Sub-Saharan Africa; Europe and North Africa; and Asia-Pacific and Middle East – in place of the previous four. The creation of these three new regions has simplified the existing structure by rationalising the complexity and scale of existing direct reporting business units (DRBUs) and has pushed decision making further down the organisation by creating fewer, larger DRBUs. These changes took effect from 1 January 2018 and the revised regional structure will therefore form the basis of our reporting going forward.

To facilitate these changes, we created the new role of Chief Operating Officer for the International business – reporting directly to me and managing our global business outside the US. The President and CEO of RAI also reports directly to me and leads our business in the US – reflecting its scale and the importance of ensuring a smooth integration that does not impact ongoing business delivery.

Confidence in future growth

The Group’s results in 2017 are testament to our commitment to delivering strong results for shareholders whilst at the same time investing substantially in the long-term future of the business. Following our acquisition of RAI, and the progress we are making with NGPs, we can now accelerate our ambition to transform tobacco. With the right people, products and strategy we are ideally positioned to deliver greater choice for our consumers, potential benefits for society as a whole and long-term sustainable value for shareholders.

Nicandro Durante

Chief Executive

 

 

 

   
BAT Annual Report and Form 20-F 2017   13


Table of Contents

 

 Strategic Management 

 

                                  

 

Finance Director’s overview

 

“These financial results illustrate the
ongoing  strength of the Group – 
delivering
against the financial objectives whilst
Investing for the changing environment”

 

Ben Stevens

Finance Director

  

 

 

 

LOGO

 

 

 

Another set of good financial results

The Group delivered another set of good financial results in 2017. Whilst the results are dominated by the inclusion of RAI as a wholly owned subsidiary since the acquisition date of 25 July 2017, the Group continued to perform well on an organic basis.

The Group’s results continued to benefit from the weakness in sterling which, due to the Group’s operating results being predominantly delivered in local currency and converted to sterling for reporting purposes, acted as a tailwind of 4%.

Increased revenue and profit from operations

Revenue grew by 37.6%, or by 2.9% excluding the impact of acquisitions and excise on bought-in goods, and on a constant currency basis. This was driven by pricing and the growth of NGPs, notably in Asia Pacific, more than offsetting a decline in organic volume.

Profit from operations was up 39.1%, as the inclusion of RAI and growth in revenue more than offset the marketing investment in NGPs, the amortisation of acquired brands and costs incurred as part of the Group’s restructuring programme.

Adjusted profit from operations on a constant currency, organic basis was up 3.7%.

A full reconciliation of our results under IFRS to adjusted revenue and adjusted profit from operations is provided on pages 218 and 219.

All regions performed well (as described on pages 42 to 47) on a constant rate basis, in challenging conditions. Asia Pacific delivered an increase in adjusted profit from operations whilst supporting the roll-out of NGPs in Japan and South Korea.

In Americas, adjusted profit from operations was up as growth in Canada, Chile and Mexico more than offset the continued economic challenges in Brazil. Transactional foreign exchange headwinds and difficult trading in Russia, GCC and South Africa led to adjusted profit from operations in EEMEA being marginally lower than prior year. In Western Europe, adjusted profit from operations was up driven by Romania and Germany.

Operating margin increasing,

with net finance costs and tax

impacted by the RAI transaction

Our operating margin increased by 270 bps, driven by the performance of the organic business and by RAI, which had a positive mix effect on margin, and partly due to the US$70 million synergies achieved by the year end. Organic adjusted operating margin increased by 40 bps.

Net finance costs grew as the Group incurred an increase in borrowings to support the acquisition of RAI. Our banking facilities require a gross interest cover of at least 4.5 times. In 2017 this was 7.8 times (2016: 12.2 times).

Due to the change in reporting of RAI as a wholly owned subsidiary following the acquisition, the Group recognised a deemed gain of £23,288 million on the deemed disposal of RAI as an associate. Our other material associate, ITC, continued to perform well.

Due to the impact of the deferred tax credit (£9.6 billion) arising from the US tax reforms, our tax charge was a net credit of £8,113 million, being a tax rate of 27.4% (credit) compared to 22.5% (charge) in 2016. This is also affected the inclusion of associates post-tax income, in our pre-tax profits. On an underlying basis, excluding such impacts and the affect of adjusting items, the tax rate was a charge of 29.7%, a marginal decrease on 2016 (29.8%).

Continuing strength

of cash flow generation

Net cash generated from operating activities grew by 16.0% to £5,347 million, largely due to the cash generated by RAI subsequent to the acquisition, the profit from operations earned in the period from the rest of the Group and a reduction in inventories. This more than offset an increase in receivables, reduction in trade and other payables, the payment of the 2017 liability related to the Master Settlement Agreement (MSA) in the United States and the final quarterly payments in relation to the Quebec Class Action.

    

    

    

Based upon net cash generated from operating activities, the Group’s cash conversion ratio decreased from 99% in 2016 to 83% in 2017.

Delivering in a period of change

These financial results illustrate the ongoing strength of the Group – delivering against the financial objectives whilst investing for the changing environment and managing the various challenges that working in a global business bring.

Ben Stevens

Finance Director

 

 

    

    

 

 

 

   
14   BAT Annual Report and Form 20-F 2017


Table of Contents
    

 

Strategic Report

 

       

 

Governance

 

       

 

Financial Statements

 

       

 

Other Information

 

 

Global market overview*

 

The advent and growth of potentially reduced-risk products, including Next Generation Products (NGPs) like vapour and tobacco heating products (THPs), combined with a mix of regulation and changing societal attitudes, has seen a gradual fall in the number of combustible cigarettes consumed over many years.

 

While more than one-fifth of the world’s adult population smokes, and most of them smoke traditional cigarettes, the global NGP market is set to more than double between 2016 and 2021, with different products set to lead this growth in different markets.

 

 

The global NGP market is predicted to more than double between 2016 and 2021, with growth coming from a diverse array of products.

 

The US remains one of the biggest NGP markets. However, the NGP market in Asia-Pacific is now growing at a rate of 65% thanks, in part, to the launch of a number of dynamic new products, with THPs emerging strongly in the region. For example, Japan has become the world’s most important THP market, and the Group estimates that, in 2018, THPs will already account for more than 20% of tobacco consumption there.

 

Vapour products are predicted to dominate in two regions: Western Europe and the US. These markets have already seen a strong and growing appetite for e-cigarettes, despite a fall in popularity for ‘cig-a-like’ style products.

 

Oral tobacco sales are growing in both Scandinavia (snus) and the US (snus and moist snuff).

 

NGP regulation – The NGP market (comprising vapour and THPs) is relatively nascent, and therefore regulation is also in its early stages. Globally, there is a mix of attitudes between regulators who aim to encourage NGPs as products that are potentially lower risk for smokers and those who view them with greater scepticism – including some countries where they are banned.

 

The UK is an example of what can happen with the support of regulators and public health bodies. Public Health England’s and the Royal College of Physicians’ major reports on the reduced risk of e-cigarettes – combined with a more liberal approach to regulation – are potential contributing factors to an increase in product uptake.

 

In the US, the Food and Drug Administration (FDA) Commissioner Scott Gottlieb made clear, in July 2017, that he wanted the FDA to strike an appropriate balance between regulation and encouraging the development of innovative products that may be less dangerous than cigarettes – potentially paving the way for greater acceptance of vapour products and THPs in the US and beyond.

 

As the income from traditional cigarette taxation falls over the longer term, there is a clear risk of increased taxation on NGPs that does not take into account their relative risks when compared with traditional cigarettes.

 

LOGO   see pages 48 to 54 to learn more about the Principal Group risk factors

Global combustible market

 

The most recent estimates for the global tobacco market (2016) indicate it is worth approximately US$760 billion (excluding China). More than US$680 billion of this comes from the sale of conventional cigarettes, with some 5,505 billion cigarettes consumed per year.

 

However, the Group estimates there has been a 3.5% fall in industry overall volume between 2017 and 2016. This is a trend which is predicted to continue as attitudes change; the sale of illicit cigarettes continues to rise; regulation increases further; and alternative, potentially reduced-risk tobacco and nicotine products continue to develop and become more consumer-acceptable.

 

Illicit tobacco – Cigarettes are a reliable source of tax revenue for governments worldwide. However, the increase in their price and broader macroeconomic pressures are leading to a growth in the illicit cigarette trade. The World Health Organization (WHO) estimates that 1 in every 10 cigarettes and tobacco products consumed globally is illicit, with the market supported by various players, ranging from individuals to organised criminal networks involved in arms and human trafficking.

 

It is generally accepted that there is a direct correlation between steep and ad hoc increases in tax and an increase in illicit sales. For example, the Australasia region is expected to see legal volumes decline substantially, following successive excise increases and illicit volumes increase.

 

However, the current relative punishments versus the profits for illegally selling tobacco products make them an appealing prospect for criminals.

 

Combustible regulation – Tobacco is one of the world’s most regulated and most taxed industries. Manufacturers are expected to comply with a swathe of regulations that are highly varied across markets.

 

Over the past decades, legislation and subsequent regulation has focused on the introduction of plain packaging, product specific regulation, graphic health warnings on packs, tougher restrictions on smoking in enclosed public places and bans on shops displaying tobacco products at the point of sale.

 

Litigation – Legal and regulatory court proceedings continue in a number of forms against the tobacco industry, with the most common being third-party reimbursement cases, class actions and individual lawsuits.

 

Special factors that led to product liability litigation in the US and Canada are not typically replicated in other countries, which is why large volume and high-value litigation has not generally spread to other parts of the globe.

 

The industry has a proven track record of defending its rights and managing risks such as these.

 

Global potentially reduced-risk products market

 

The global tobacco and nicotine market is increasingly diversifying beyond traditional combustible tobacco with the growth of NGPs as well as the oral tobacco and nicotine market (e.g., snus and moist snuff).

 

The latest global figures (2016) suggest the NGP market is worth an estimated US$12.3 billion, a 34% increase on the previous year, while the oral tobacco and nicotine market is worth an estimated US$12.5 billion – demonstrating how quickly the nascent NGP category has progressed against a more mature category.

 
   

*  All data sources on this page are from Euromonitor International unless otherwise stated.

 

   
BAT Annual Report and Form 20-F 2017   15


Table of Contents

 

 Strategic Management 

 

                                  

 

Our global business

British American Tobacco is a leading, multi-category consumer goods company that provides tobacco and nicotine products to millions of consumers around the world.

With market leadership in over 55 countries and cigarette factories in 42 we have genuine global reach. Our world-class portfolio of cigarette brands is complemented by our increasing range of potentially reduced-risk products. This includes our Next Generation Products, comprising our vapour and tobacco heating products, and our oral tobacco and nicotine products such as moist snuff and snus.

Following the acquisition of leading brands in the US, as well as the growing importance and progress of our potentially reduced-risk products, we have established a portfolio of priority brands – our Strategic Portfolio – to replace the Global Drive Brands (Dunhill, Kent, Lucky Strike, Pall Mall and Rothmans).

 

Our geographic diversity   

55+

 

  

45

 

  

BAT is a truly global consumer goods company with brands sold in over 200 markets. In 2017, we had strong market positions in each of our five regions*, outlined here.

 

        
   countries where we are market leader   

cigarette factories in 42 countries

  
        
We have one principal associate company – ITC Ltd in India – and we also have a joint operation, CTBAT, with China National Tobacco Corporation.         

 

LOGO

 

* As of 1 January 2018, the Group’s International regional structure (ex US) was reduced to three regions comprising: Americas and Sub-Saharan Africa; Europe and North Africa; and Asia-Pacific and Middle East.  

 

   
16   BAT Annual Report and Form 20-F 2017


Table of Contents
    

 

Strategic Report

 

       

 

Governance

 

       

 

Financial Statements

 

       

 

Other Information

 

 

Our Strategic Portfolio, as set out below, reflects our priority to provide consumers with a range of potentially reduced-risk products while recognising the important role that our combustible brands play in delivering ongoing value for shareholders and the funds required to invest further in our Next Generation Products.

We also have many international and local cigarette brands which, although not part of our Strategic Portfolio, play an important role in delivering the Group’s strategy in a number of Key Markets.

 

LOGO

 

   
BAT Annual Report and Form 20-F 2017   17


Table of Contents

 

 Strategic Management 

 

                                  

 

Our business model

 

At the centre of our global business, operating in over 200 markets, is the manufacture and marketing of superior combustible tobacco products and potentially reduced-risk products – this includes our Next Generation Products (NGPs), comprising vapour and tobacco heating products (THPs), alongside oral tobacco and nicotine products such as moist snuff and snus.

 

Our sustainable approach to sourcing, production, distribution and marketing helps us to create value for a wide group of stakeholders, from farmers to consumers.

 

We use our unique strengths and employ our resources and relationships to deliver sustainable growth in earnings for our shareholders.

 

LOGO    For more information on the structure of the Group, see page 216.

 

  LOGO

 

   
18   BAT Annual Report and Form 20-F 2017


Table of Contents
    

 

Strategic Report

 

       

 

Governance

 

       

 

Financial Statements

 

       

 

Other Information

 

 

 

LOGO

 

   
BAT Annual Report and Form 20-F 2017   19


Table of Contents

 

 Strategic Management 

 

                                  

 


 

Delivering our strategy

 

LOGO

 

  

 

Growth

 

Our multi-category portfolio of brands continued

to deliver in 2017, driven by our Global Drive Brands

and Next Generation Products.

 

Highlights during the year

 

–  Group revenue grew by 37.6% at current rates of exchange.

 

–  Group market share in Key Markets up by over 40 bps.

 

–  Global Drive Brands’ cigarette volume grew 10.0% (+7.6% organic).

 

–  The Group established itself as the world’s leading tobacco and Next Generation Products business by revenue and profit.

 

 

Business performance

Group revenue, at current rates of exchange, was 37.6% higher than 2016, driven by the acquisition and subsequent consolidation of Reynolds American, pricing, growth of the Next Generation Product (NGP) portfolio and the continued relative weakness of sterling. At constant rates of exchange, adjusted (excluding excise on goods bought-in from third parties), organic revenue was up 2.9%.

Group cigarette and THP volume from subsidiaries was 686 billion, an increase of 3.2% against the previous year and a decline of 2.6% on an organic basis as volume growth in Bangladesh, Bulgaria, Nigeria and GCC was offset by declines in Pakistan, Russia, Ukraine and Brazil.

The Group’s cigarette and THP market share in its Key Markets continued to grow, up 40 basis points (bps). This was driven by another excellent performance by our Global Drive Brand (GDB) portfolio with volume up 7.6% on an organic basis and market share, outside the US, increasing 110 bps, driven by growth in Brazil, Pakistan, Turkey and Mexico. Volume growth of our GDBs, including Key Strategic Brands (together known as GDSBs) was up 17.2% or 7.5% on an organic basis.

The Group’s NGP portfolio contributed £397 million of revenue, at current rates of exchange, which includes the contribution from RAI Companies’ brands since the acquisition date. Including a full year’s revenue from RAI, in 2017, revenue from NGPs was approximately £500 million.

In 2018, we expect to generate over £1 billion in revenue from our NGPs, rising to more than £5 billion in 2022.

We expect the NGP business to break even by end 2018 and to deliver substantial profit by 2022.

Global Drive Brands

Our five leading brands GDBs – are Dunhill, Kent, Lucky Strike, Pall Mall and Rothmans.

The Group’s market share has grown consistently over the last seven years, powered by our GDBs. They play a key role in our growth strategy and now account for over 50% of all the cigarettes and THPs we sell (ex US).

Dunhill: Overall market share was down 10 bps with volume lower by 5.9%, driven by the economic slowdown impacting consumers’ disposable income in Indonesia and continued down-trading in Malaysia and GCC, and industry contraction in South Korea.

Kent: Volume increased by 11.2%, with market share up 30 bps, driven by Japan, due to the success of glo, Turkey and Brazil, offsetting a decline in Iran.

Lucky Strike: Market share and volume grew by 20 bps and 12.2% respectively, with growth in Indonesia and Spain more than offsetting reductions in Argentina and Egypt.

Pall Mall: Market share grew 20 bps, with volume up 14.8%, or 6.4% on an organic basis, as growth in GCC, Nigeria and Poland more than offset Chile and Russia.

Rothmans: Volume increased 14.3%, with market share up 40 bps, driven by Russia, Poland, Nigeria and Colombia, offsetting lower volume in Kazakhstan and Egypt.

 

 

 

 

 

 

Revenue

(£m)

 

LOGO

 

 

Change in adjusted revenue

at constant rates (%)

 

LOGO

 

 

Global Drive Brands (GDBs)

cigarette volume and THP volume

 

LOGO

 

 

Global Drive and Key Strategic Brands

(GDSBs) total cigarettes and THP volume

 

LOGO

 

 

   
20   BAT Annual Report and Form 20-F 2017


Table of Contents
    

 

Strategic Report

 

       

 

Governance

 

       

 

Financial Statements

 

       

 

Other Information

 

 

 

 


 

Group market share of key markets

 

LOGO

 

 

Total shareholder return (TSR) of the

FMCG group – 1 January 2015

to 31 December 2017 (%)

The FMCG group comparison is based

on three months’ average values

 

LOGO

US cigarette brands

In the period since acquisition, RAI Companies’ cigarette volume in the US was 36 billion, outperforming the industry with total cigarette market share at 34.7%, up 20 bps on 2016.

Newport and Natural American Spirit continued to grow market share driven by the investment into the trade and, together, they are the fastest growing premium brands on the market. Camel market share increased due to the performance of the menthol range. Pall Mall market share was lower due to price competition in the value for money category.

Local and international

cigarette brands

We have many other international and local cigarette brands including Vogue, Viceroy, Kool, Peter Stuyvesant, Craven A, Benson & Hedges, John Player Gold Leaf, State Express 555 and Shuang Xi.

Although experiencing a slow overall decline, our local and international brands continue to play an important role in delivering the Group’s Strategy in several Key Markets, including Brazil, South Africa, Vietnam, Pakistan, Bangladesh and Japan.

Other international brands declined by 13.4%, as growth in State Express 555 and B&H was more than offset by lower volume from Craven A, Viceroy, Peter Stuyvesant, John Player Gold Leaf, and Vogue.

Combustible product

Innovations1

In addition to innovations in our NGP portfolio, innovations in our combustible tobacco portfolio remain an important part of our strategy to provide consumers with a range of exciting and differentiated products from which to choose.

Innovations volume grew by 11.6%, driven by the continued growth of tube filters and capsules which now account for 37% of our cigarette volume.

Potentially reduced-risk products

Potentially reduced-risk products is the term we use to define our Next Generation Product (NGP) business, comprising vapour and THPs, and our oral tobacco and nicotine business, including products such as snus and moist snuff.

We are seeking leadership of the entire category and have a suite of products to cater for consumers’ many and varying preferences.

In 2017, we further enhanced our range of potentially reduced-risk products with the acquisition of the e-cigarette brand ViP in the UK and Winnington, the maker of Epok, the market leading white snus product in Sweden.

Vapour products

Following the acquisition of Reynolds American we are now the world’s leading vapour company.

Outside of the US, the Group has market leadership in Poland and the UK, with the latter driven by the two fastest growing vapour brands in the market, Vype and Ten Motives. Vype is now present in nine markets (and in duty free via our Global Travel Retail business) and, while still immaterial in the context of the Group, our European vapour business grew with revenue up strongly against the same period last year.

In the US, the R.J. Reynolds Vapor Company – a Reynolds American operating company – was formed in 2012 and started selling Vuse digital vapour products in Colorado in June 2013 before expanding nationally in 2014. The Vuse range of products continues to have a significant presence in the market.

The Group has a range of products covering open and closed vapour systems, all designed to meet the emerging preferences of consumers. We also have a strong product pipeline in place to cater for changing preferences in this category.

 

 

1. Defined as any Group-manufactured cigarette containing non-standard features such as slims, capsules, Reloc or tubes.

In addition to revenue and the other measures discussed in this Annual Report and Form 20-F, BAT management focuses on volume as a key measure to evaluate performance. Volume is an unaudited operating measure and is calculated as the total global cigarette and THP volume of the Group’s brands sold by its subsidiaries. The Group believes that volume is a measure commonly used by analysts and investors in the industry. Accordingly, this information has been disclosed to permit a more complete analysis of the Group’s operating performance.

The Group also uses market share to evaluate its performance. The Group evaluates changes in its retail market share, or market share, in its key markets for tobacco products, based on the latest available data from a number of internal and external sources. Key markets consist of approximately 40 territories across all geographical segments, and represent approximately 80% of the Group’s global volume. Growth in these markets is largely driven by the Global Drive Brands. The Group also highlights drivers for change in specific markets (e.g., volume or market share). For Next Generation Products, the Group monitors its performance in select countries (e.g., UK, Germany, Italy) based upon category retail market share, based on the latest available data from a number of internal and external sources. In addition, the Group’s performance is affected by global pricing, which is impacted by discounts, terms of credit with customers, excise taxes and other competitive, market-driven and regulatory factors. In certain markets, the Group has experienced increases or decreases in average prices resulting from changes in product mix, also referred to as price mix. The Group believes that pricing and market share are measures commonly used by analysts and investors in the industry.

 

   
BAT Annual Report and Form 20-F 2017   21


Table of Contents

 

 Strategic Management 

 

                                  

Delivering our strategy continued

 

 

Tobacco heating products

Our tobacco heating product (THP), glo, is present in six markets – Japan, South Korea, Russia, Romania, Canada and Switzerland – with additional launches planned for 2018.

Following the initial launch of glo in the Japanese city of Sendai in December 2016, we rolled the product out nationally in October 2017. We are already at 3.6% market share in Japan and our research shows that, in Tokyo, three out of four new consumers in the category are choosing glo over other products on the market.

We launched glo in the South Korean city of Seoul in August 2017 and subsequently expanded into three more cities – Busan, Daegu and Daejeon – with continuous market share growth being captured at national level. Encouraging progress is also being made in the other markets where glo is present and we have a number of market and new product launches planned for 2018 and beyond.

To support our on-going glo expansion plans, and to meet the increasing demand, investment in Neostik (our glo consumables) production capacity has taken place in South Korea and Russia.

Oral tobacco and nicotine products

In the US, American Snuff Company, LLC’s volume of moist snuff was 228 million cans in the period since the acquisition of Reynolds American. Total moist market share was up 100 bps on 2016 to 34.4%, primarily due to Grizzly, a leading US moist snuff brand, benefiting from its strength in the pouch and wintergreen categories, as well as the recent national expansion of its Dark Select style.

Change to performance measure

Revenue Growth from the Strategic Portfolio – effective 2018

The Group continuously assesses the performance metrics to ensure they remain relevant to reflect the Group’s short- and long-term delivery in line with the strategic vision. To that end, from 2018, the Group will introduce a new measure called Revenue Growth from the Strategic Portfolio, as part of the short-term incentive scheme. This will have a 30% weighting, with the Strategic Portfolio reflecting the focus of the Group’s investment activity, and defined as:

 

The GDBs (Kent, Dunhill, Lucky Strike, Pall Mall and Rothmans);

 

The three main brands from the US business (Camel, Newport and Natural American Spirit); and

 

Key brands within our potentially reduced-risk products portfolio.

The new metric will replace the Global Drive Brand (GDB) & Key Strategic Brand (KSB) volume growth metric. The volume share metric of key markets is retained with a weighting reduced from 20% to 10%.

In 2017, while not part of the Group’s KPIs, to provide the comparator against which 2018 will be measured, Revenue from the Strategic Portfolio was £16,711 million assuming we had owned RAI for the full 12 months and after the implementation of the new accounting requirements of IFRS 15.

    

 

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22   BAT Annual Report and Form 20-F 2017


Table of Contents
    

 

Strategic Report

 

       

 

Governance

 

       

 

Financial Statements

 

       

 

Other Information

 

 

LOGO    Productivity

 

We have continued our drive towards a more effective and efficient globally integrated organisation by leveraging global systems and new ways of working. This global integration ensures the lowest possible overheads, the most cost-effective and responsive supply chain and that productivity opportunities are fully exploited.

 

Highlights during the year

 

–  Record productivity savings delivered.

 

–  Opening of the new Global Supply Chain Service centre in Southampton, UK and further expanded shared services for Human Resources and Finance in Romania.

 

–  Continued optimisation of leaf growing and manufacturing locations.

 

 

Globalising operations and improving efficiency

Global systems and ways of working across the Group are exploited to minimise our cost base and maximise expertise. Furthermore, by ensuring back-office activities are carried out most efficiently and effectively, the end markets are free to focus their efforts on sales activities. This drive to a globally integrated enterprise is most apparent in our Supply Chain, Human Resources, Finance, Procurement and Information Technology functions.

In line with this strategy, during 2017 the Group opened a new Global Supply Chain Service centre in Southampton, UK and further expanded shared services for Human Resources and Finance in Romania. In all cases, these opportunities have been enabled by the Group’s single global SAP system.

The successful completion of the migration of Croatia, Greece, Serbia and Indonesia to our single system at the start of the year has meant that during 2017 the Group has been able to focus on embedding expertise and rolling out initiatives to leverage the Group’s global integration.

The drive towards above-market aggregation is not only reducing cost through less duplication, but also ensuring the best expertise is exploited throughout the Group. Doing so helps ensure resources are made available to establish more global activities across our combustible and Next Generation Product (NGP) businesses and that those activities are implemented efficiently and effectively.

In Supply Chain, the Group is integrated globally such that the single view of future demand ensures resources and investments can be most effectively prioritised.

This includes machinery investment so that capital expenditure is targeted to the areas of the business with the greatest return on the investment. This global view also enhances our ability to react quickly in situations when speed to market gives us a competitive advantage.

Continued strategic investments in new machinery in 2017, supported by our global planning systems and integrated business model, have ensured we deliver ‘on time and in full’ in all our Key Markets at optimal cost, with speed and scale.

 
Profit from operations
(£m)

LOGO

 

Change in adjusted profit from
operations at constant rates (%)

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BAT Annual Report and Form 20-F 2017   23


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Delivering our strategy continued

 

Net cash generated from operating

activities (£m)

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Operating margin

(%)

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Adjusted operating margin

(%)

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Continued optimisation of manufacturing locations and leaf growing

In 2017, we continued to optimise our manufacturing footprint and at the end of the year had 45 cigarette factories in 42 countries. In addition, the acquisition of Reynolds American added a further six manufacturing facilities to the Group.

The Malaysia factory was closed this year and the German factory was refocused on OTP, Dry Ice Expanded Tobacco (DIET) and Casing/ Flavours Manufacture – with the ending of cigarette manufacture planned for early 2018. This factory reduction is balanced against continued strategic acquisitions to support the Growth Agenda.

Factory expansions in Romania and South Korea to accommodate new opportunities in NGPs, specifically consumables production for glo, show how our sourcing is responsive to innovative growth demands while remaining cost effective. This complements substantial investment in device capacity, which is also taking place in response to increased consumer demand for glo.

We are continually looking to improve the efficiency of our entire supply chain with the opportunities to improve our manufacturing operations being a focus in 2017, continuing into 2018. We are realising the benefits of our Integrated Work Systems, a programme that is designed to maximise equipment efficiency while ensuring we maintain high standards of product quality.

The improved equipment efficiency is delivering real benefits through improved productivity and lower maintenance costs together with reduced waste. An additional positive by-product is the release of capital expenditure which can be used to invest in further innovation.

While the Group does not own tobacco farms or directly employ farmers, it sources over 400,000 tons of tobacco leaf each year directly from over 90,000 contracted farmers and through third-party suppliers mainly in developing countries and emerging markets in Africa, Asia and Latin America. The Group also purchases tobacco leaf from India where the tobacco is bought over an auction floor. The price of tobacco in US dollars varies from year-to-year driven by domestic inflationary pressures, supply, demand and quality. The Group believes there is an adequate supply of tobacco leaf in the world markets to satisfy its current and anticipated production requirements.

Record productivity savings

By operating globally, exploiting our systems and driving for results, the Group delivered record productivity savings in 2017. This has been reinforced by the acquisition of Reynolds American which will provide further opportunities for productivity savings.

These savings are returned to the business for re-investment and to increase shareholder return. The following examples show how the Group considers all opportunities in the supply chain, including Procurement, International logistics and Leaf operations:

Procurement – Global visibility of forward demand and product specifications in one system has delivered significant benefit with the tender at a global level of print materials and tow being notable examples. In addition to the benefits of lower product cost, the development of long-term supplier relationships with key suppliers has improved security of supply and enabled higher flexibility in the supply chain.

International logistics – Whether by road, air or sea, this is now organised and controlled centrally. This facilitates opportunities to negotiate globally with third-party providers for us to benefit from our scale. Furthermore, this maximises the use of return shipments and economic order quantities to ensure maximum efficiency while maintaining the flexibility for fast response to market opportunities.

Leaf operations – These are similarly managed globally to ensure that the Group works with reliable, efficient and responsible farmers in our source countries. Our Global Leaf Pool operation aggregates demand to meet supply across all internationally traded tobacco. This approach balances the lowest possible working capital investment while reducing any exposure to climatic impacts on our crops and guaranteeing the best quality leaf to meet consumer demands.

While transactional foreign exchange rates again negatively impacted on our cost base in 2017, by continuing to improve our productivity in all areas of our supply chain and elsewhere in the Group, we can increase our profitability and continue to deliver returns to our shareholders today and invest in the future.

 

 

 

 

   
24   BAT Annual Report and Form 20-F 2017


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Financial Statements

 

       

 

Other Information

 

 

LOGO

 

  Winning organisation     

 

Group diversity

 

            

 

Total

 

 

 

   

 

Male

 

 

 

   

 

Female

 

 

 

 

 

We enable growth by having a winning organisation: by investing in our people, by attracting the best, and by enhancing the high performing leaders who inspire diverse teams of committed and engaged people in a fulfilling, rewarding and responsible work environment.

 

Highlights during the year

 

–  Accelerated talent development and attraction in growth markets and growth categories including the Next Generation Products business.

 

–  Doubled our intake to the global graduate programme focused on developing the commercial acumen of our junior talent.

 

–  Certified as a Top Employer in Europe, Africa and Asia-Pacific by the Top Employer Institute.

 

–  Exceptionally strong employee engagement and culture of passion and commitment shown through the most recent employee opinion survey in 2017.

     Main Board     13       9       4    
     Senior management     740       584       156    
     Total Group employees     55,761       42,452       13,309    
    

 

LOGO

 

 

Investing in leaders

The quality of our people is a major reason why the Group continues to perform well. In return, we commit to investing in our people as we do in our brands.

The long-term culture of the Group has been about developing talent from within, stretching and supporting the high-performing managers who will lead the delivery of our strategy. This year, over 92% of our senior appointments were drawn from people already within the business – moves that have helped to deliver stronger and more diverse leadership teams and succession plans.

2017 saw the introduction of our new Global Graduate Academy: an intensive two-week programme focusing on accelerating the development of commercial leadership in our next generation of leaders. Over two cohorts during the year, 108 global graduates from 37 countries came together in London for a challenging and interactive learning experience supported by senior leaders from across the business.

We continually update our capability frameworks and learning portfolio to enable development of new capabilities to drive business performance. In 2017, we launched new programmes across Leadership, Marketing, Legal and External Affairs and R&D. These included a new leadership programme for junior managers integrated with leading edge digital content and programmes focusing on brand-building and Next Generation Products.

 

LOGO   

You can learn more about our

Global Graduate Programme at

www.bat-careers.com/graduates

Attracting the best talent

When we do recruit externally, we actively seek those who will provide additional knowledge and skills that will strengthen our teams and ultimately make us a stronger business. In 2017, we continued to enhance our internal capabilities to engage and recruit those people who will help us win in growth markets and growth categories including Next Generation Products.

We continued the digital growth of our employer brand – ‘Bring your Difference’ – across core social media channels. We have more than doubled our followership on Facebook and increased followership by 20% on LinkedIn. We are leading the industry in social media engagement and have moved ahead of several top FMCG companies.

As competition for talented employees intensifies, people increasingly want to work for businesses with a good corporate reputation, so we are proud to have been ranked among the top employers around the world and have been named as a Top Employer for Europe, Africa and Asia-Pacific by the Top Employer Institute, an independent global certification company. We also received similar accolades in many of the countries in which we operate.

Growth through diversity

Diversity matters to the Group because it makes good commercial sense – having a diverse workforce means we are better able to understand and meet the varied preferences of our global consumers. Our efforts to drive diversity are built on three pillars of driving ownership and accountability, building diverse talent pools and creating enablers; all of which are underpinned by an inclusive culture.

Nationalities represented*

 

 

       Total  
Main Board      7  
Global headquarters      77  
Management level globally      143  
  

Employee engagement index

 

 

LOGO

 

 

Senior managers: Companies Act 2006  
For the purposes of disclosure under section 414C(8) of the Companies Act 2006, the Group had 203 male and 26 female senior managers. Senior managers are defined here as the members of the Management Board (excluding the Executive Directors) and the directors of the Group’s principal subsidiary undertakings. The principal subsidiary undertakings, as set out in the Financial Statements, represented approximately 70% of the Group’s employees and contributed around 76% of Group revenue and profit from operations in 2017.  

*  Excluding data for RAI Companies as this was not tracked before the acquisition in July 2017.

   

 

 

   
BAT Annual Report and Form 20-F 2017   25


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Delivering our strategy continued

 

We are a diverse employer. There are 143 nationalities represented at management level within our Group, and 35 within our executive cadre*. We are pleased with the continuous progress we are making and the sustainable pipeline we are building in terms of nationality diversity.

We are also proud of the notable progress and achievements we made in 2017 in gender diversity. We achieved 31% female representation on our Board and increased the female representation in senior management to 21% in 2017, which was largely driven by internal promotions. We also have female executives on all our senior functional and geographical leadership teams. Over 50% of our graduate intake were females, ensuring a sustainable pipeline of women for senior management roles.

Several initiatives have been instrumental in the progress we have made. Our ‘Women in Leadership’ programme is designed to support and accelerate the development and career progression of female talent. In 2017, we trained 145 women across the Group – a number equal to those trained in the previous three years combined. Furthermore, two new diversity training modules, Inclusive Leadership and Cross-Cultural Awareness, have been developed and are being rolled-out to all management employees.

Providing women and other diverse groups an opportunity to connect, engage and share experiences is one of our key enablers; we have more than ten different affinity groups globally to support this. The newest of these affinity groups, Women in BAT UK, was launched in June 2017 and has already amassed more than 350 members.

Our regions and end markets also work to progress the global diversity strategy through on-the-ground initiatives relevant to local cultures and contexts.

In March 2018, we will be publishing data relating to UK Gender Pay in line with statutory requirements. We are confident that men and women are rewarded equally for similar roles, however, we do have a “gender pay gap” as defined by the UK legislation. This is largely a reflection of having more men than women in senior roles and is something we are committed to addressing through initiatives like those outlined above.

 

LOGO  

 

You can learn more about our published data relating to UK Gender Pay in line with statutory requirements at www.bat.com/genderpayreport

Safe place to work

We are committed to providing a safe working environment for all our employees and contractors, and have a Group-wide goal of zero accidents. Our approach is based on risk management and assessments, employee training and awareness, and specific initiatives for high-risk areas of our business.

The vast majority of all Group accidents are in Trade Marketing & Distribution (TM&D), where we have over 29,800 vehicles and motorcycles out on the road every day. Many of these are in challenging parts of the world with high levels of road traffic accidents and armed robberies.

Our driver safety and security programme continues to focus on addressing these risks, such as through the use of in-vehicle ‘telematics’ monitoring systems to analyse driver behaviour data, insights from which are used to tailor our training programmes to improve driving skills and hazard perception. Since 2014, all our vehicles are required to meet strict safety specifications, and we also continually assess threat levels to enhance security protocols and escorts in high-risk locations.

In 2017, accidents across the Group increased significantly, from 182 in 2016**, up to 217. Sadly, this included an increase in fatalities, with the death of a contracting electrician in our factory in Bangladesh from contact with electricity; two TM&D contractors who died in road traffic accidents in Brazil; and one TM&D employee and eight TM&D security contractors who died in violent attacks in Brazil and South Africa. Eleven members of the public also lost their lives in road traffic accidents involving BAT vehicles in eight countries.

We deeply regret this loss of life and the suffering caused to friends, family and colleagues. We liaise closely with the relevant authorities and conduct our own detailed investigations to determine the root cause of each accident, identify any lessons that can be learned and implement action plans, the outcomes of which are reviewed at Board-level.

Overall, our driver and vehicle safety programmes have led to a decline in road traffic accidents in 2017 involving cars or vans, but this was offset by a rise in accidents involving motorcycles, which we have increased the use of in markets where the high density of traffic means they are a more practical option. To address the increased risks, we have put in place motorcycle training programmes in all markets, where motorcycles have been recently introduced, to provide practical techniques for different road conditions and types of traffic, safe speeds and distances, and how to spot a potential problem and take action to deal with it safely.

Equal opportunities for all

We are committed to providing equal opportunities to all employees. We do not discriminate when making decisions on hiring, promotion or retirement on the grounds of race, colour, gender, age, social class, religion, smoking habits, sexual orientation, politics or disability, subject to the inherent requirements of the role to be performed. We are committed to providing training and development for employees with disabilities.

Leadership for change

The world is changing fast. The accelerated pace of transformation both in our industry and the organisation demands that our people are ambitious, courageous and resilient; that they learn quickly and are responsive to opportunities; and that they continue to drive and own results. As our organisation evolves, we continue to focus on these traits and on what has served the Group well through its history – having a culture of passionate owners and having people who lead and inspire each other for the journey ahead.

In 2017, we ran the Group’s global employee survey. We received extraordinary results. The survey had a response rate of 95% – 10 percentage points higher than the average response rate for this type of survey – with the Engagement Index score of 83% being 12 percentage points higher than the FMCG comparator norm of 71% (see chart on page 25). This survey conveys the pride which many employees have in working for us and is demonstrable as we have continued to see employee turnover stay below comparator benchmarks.

Rewarding people

Reward is a key pillar in ensuring that we have the right people to drive the business forward. Reward is necessarily local and we strongly support this through global frameworks to ensure leading edge policies, processes and technology are available to all markets. Base pay rewards core competence relative to skills, experience and contribution to the Group, while annual bonuses, recognition schemes and ad hoc incentives provide the right mix to ensure that high performance is recognised and rewarded. The Long-Term Incentive Plan (LTIP) has been established to make annual awards of free shares to senior managers provided certain challenging long-term performance conditions are met. The LTIP is one element of senior executives’ reward package aiming to align the interests of the Group’s senior managers with those of shareholders. Further information on the Group’s Remuneration Policy for the Executive Directors and the Non-Executive Directors can be found on pages 73 to 98.

We also offer our UK employees the chance to share in our success via our Sharesave Scheme, Partnership Share Scheme and Share Reward Scheme, and operate several similar schemes for senior management in our Group companies.

 

* Excluding data for RAI Companies as this was not tracked before the acquisition in July 2017.

 

** The 2016 figure has been updated to include reportable injuries from 2016 acquisitions. The previously reported figure was 175. Excluding data for RAI Companies as we continue the integration.
 

 

   
26   BAT Annual Report and Form 20-F 2017


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Strategic Report

 

       

 

Governance

 

       

 

Financial Statements

 

       

 

Other Information

 

 

 

LOGO

 

 

 

Sustainability

 

Sustainability is a key pillar of our Group strategy and plays a fundamental role in all aspects of our business.

 

Our sustainability agenda was developed through a detailed assessment process, which we refreshed in 2017, that identified the three key areas that have the greatest significance to our business and our stakeholders.

 

–  Harm reduction: We are committed to working to reduce the public health impact of smoking, through offering adult consumers a range of potentially reduced-risk products.

 

–  Sustainable agriculture and farmer livelihoods: We are committed to working to enable prosperous livelihoods for all farmers who supply our tobacco leaf.

 

–  Corporate behaviour: We are committed to operating to the highest standards of corporate conduct and transparency.

 

Highlights during the year

 

–  Implementation of our new operational standard on child labour prevention, which complements our long-standing Child Labour Policy

 

–  Launch of the Group’s new global compliance programme, known as ‘Delivery with Integrity’

 

–  46% reduction in carbon dioxide equivalent (CO2e) emissions from our 2000 baseline

 

LOGO

 

 

 

Read more about how we identified these issues and detailed information on our performance in each area at www.bat.com/sustainabilityreport

 

 

Harm reduction

Tobacco harm reduction is about encouraging adult smokers, who wish to continue using tobacco or nicotine products, to switch to potentially lower risk sources of nicotine as compared to conventional cigarettes. Our focus on Next Generation Products (NGPs), comprising vapour and tobacco heating products (THPs), and oral tobacco products provides an opportunity to dramatically reduce the public health impact of smoking.

 

LOGO  

 

Read about our progress in potentially reduced-risk products on pages 21 and 22

Cutting-edge science

BAT and Reynolds American share a tradition of world-leading scientific research and, following the acquisition, we are at the forefront of developing a new generation of alternatives to cigarettes, as well as pioneering new scientific methods to evaluate their harm reduction potential.

We have developed a framework of scientific tests to assess the reduced-risk potential of NGPs relative to smoking cigarettes and, in 2017, published the results of a series of studies for both our Vype ePen and our glo THP.

In 2018, we are embarking on one of our most ambitious and large-scale clinical studies, following hundreds of consumers in the UK for a full year, to look at whether switching to a NGP is as good as quitting smoking, in terms of reducing toxicant exposure and the potential impact on health.

High standards and enabling responsible growth

Following high standards to ensure quality and consumer safety is at the heart of everything we do in the design, development and manufacturing of our products. We would like to see the same approach across the whole industry, so, in 2017, we continued to advocate for, and collaboratively contribute to the development of, consistent national and international standards and proportionate regulation for NGPs.

This is essential for giving consumers the assurances they need to support take-up by more smokers which can ultimately help to realise the potential benefits for public health.

Sustainable agriculture and farmer livelihoods

Tobacco leaf remains at the core of our products, even with the growth of NGPs, so the farmers who grow it are crucial to the continued success of our business.

We have traceability down to the farm level and centralised management of our tobacco leaf supply chain. This enables an agile, efficient and reliable supply of high-quality tobacco leaf to meet consumer demand, while also enhancing the sustainability of rural communities and agriculture.

 

 

Carbon dioxide equivalent (CO2e)*

(tonnes CO2e per million cigarettes equivalent produced)

 

LOGO

 

 

Group energy use*

(gigajoules per million cigarettes equivalent produced)

 

LOGO

 

 

Water use*

(cubic metres per million cigarettes

equivalent produced)

 

LOGO

 

 

Recycling

(percentage of waste recycled)

 

LOGO

 

 

   
BAT Annual Report and Form 20-F 2017   27


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Delivering our strategy continued

 


 

In 2017, the BAT Group purchased more than 400,000 tonnes of tobacco leaf:

 

66% from 17 BAT leaf operations, which source from over 90,000 farmers; and

 

34% from 20+ third-party suppliers, which source from over 260,000 farmers.

Find our more in our Sustainable Agriculture and Farmer Livelihoods Focus Report at www.bat.com/sustainabilityfocus

Supporting our farmers

Through our global leaf research and development, we develop new and innovative farming technologies and techniques, which are rolled out to farmers as part of comprehensive agri-support packages.

We have a network of expert field technicians who provide on-the-ground support, technical assistance and capacity building for all our 90,000+ directly contracted farmers, helping them to run successful and profitable farms. Our third-party suppliers provide their own support for all the 260,000+ farmers they source from.

By supporting farmers in this way, we can help them maximise the potential of their farms and enhance the livelihoods and resilience of rural communities. They and future generations are then more likely to feel motivated to remain in agriculture, look after the environment and see the value of growing tobacco as part of a diverse range of crops.

Setting standards and driving change

We use the industry-wide Sustainable Tobacco Programme (STP) to conduct assessments and independent on-site reviews for 100% of our tier one tobacco leaf suppliers, including our own leaf operations, to ensure alignment with international standards, such as for human rights and environmental protection.

STP was introduced in June 2016, replacing our previous Social Responsibility in Tobacco Production programme, which from 2000 until 2015 set the standard for all our leaf suppliers worldwide.

Since implementation, two rounds of self-assessment have been completed, and a total of 26 independent on-site reviews have been conducted in 19 countries, covering 50% of our total supply base. By the end of 2018, 100% will have been reviewed by AB Sustain, an independent supply chain management company.

Our ‘Thrive’ sustainable agriculture and farmer livelihoods programme takes a more holistic and collaborative approach to identifying and addressing root causes and long-term risks, such as rural poverty.

Thrive assessments have been completed in 2016 and 2017 for approximately 250,000+ farmers who supply all our own 17 leaf operations and six strategic third-party leaf

suppliers (covering nearly 80% of our total tobacco leaf purchases). We are now using the results to inform our approach to selecting and developing new partnerships and community-based projects that will have a demonstrably positive impact for farmers and their communities.

Human rights in tobacco growing

Agricultural supply chains are particularly susceptible to the risks of child labour and, in 2000, as part of our long running commitment to end the practice within tobacco farming, we became a founding board member of the Eliminating Child Labour in Tobacco Growing (ECLT) Foundation. We remain active members today, alongside other major tobacco companies and leaf suppliers. ECLT helps to strengthen communities and bring together key stakeholders to develop and implement local and national approaches to tackle child labour.

We provide training and communications to farmers and rural community members to raise awareness of human rights issues, which reached over 67,000 beneficiaries in 2017. We also run on-the-ground projects in farming communities to address root causes, such as rural poverty, in collaboration with local partners.

In 2017, we developed a new operational standard on child labour prevention, with inputs from the ECLT and the International Labour Organization. This complements our long-standing Child Labour Policy and includes detailed standards, guidance and processes for our leaf operations to ensure it is effectively applied in a robust and globally consistent way.

Corporate behaviour

Our actions and behaviour impact all areas of our business – which is why corporate behaviour is such an important focus for our long-term sustainability strategy.

Our commitment to good corporate behaviour is underpinned by our Group Standards of Business Conduct (SoBC), or localised equivalent, which require all our staff worldwide to act with a high degree of business integrity, comply with applicable laws and regulations, and ensure that our standards are not compromised for the sake of results.

Delivery with integrity

In 2017, we introduced the Group’s updated compliance programme, ‘Delivery with Integrity’, focused on strengthening and driving a globally consistent approach to compliance across the Group. The programme is led by our Business Conduct & Compliance department, reporting directly to the Group Legal and External Affairs Director.

 

Sustainability reporting

 

LOGO

‘Delivery with Integrity’ is about re-emphasising our commitment to transforming tobacco in line with the highest ethical values. This is an area in which we already have strong foundations, so while this is not new for us, we are further enhancing our compliance procedures.

The importance of sustaining a culture of integrity across the Group was a key theme for our annual Group Leadership Meeting. The ‘Delivery with Integrity’ programme was launched in a two-day workshop held in London with 120 leaders from our Legal and External Affairs Function worldwide, opened by our Chief Executive. This was followed by a global ‘Delivery with Integrity’ communications campaign to all employees worldwide.

A key focus area of the programme in 2017 has been to enhance the Group’s long-standing procedures for the annual SoBC employee sign-off, with the introduction of a new online SoBC portal. The new portal is available to employees in multiple languages and provides tracking and performance reporting capabilities. Over 18,000 management-grade and office-based employees across the Group completed an online SoBC training course and assessment in the new portal in addition to their annual sign-off, and our remaining employees, who may not have easy online access, received face-to-face training.

Speak Up channels

To increase the accessibility of, and strengthen, our long-standing whistleblowing policy and procedures, in early 2018 we launched a new third-party managed Speak Up system, following a review of the Group’s existing whistleblowing procedures undertaken in 2017.

 

 

   
28   BAT Annual Report and Form 20-F 2017


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Other Information

 

 


 

 

The system includes a website available in multiple languages, and local language hotlines for our markets, and enables improved global oversight of all reported issues in real time.

Please refer to pages 69 and 70 for more information about the application of the SoBC in 2017, the Audit Committee’s responsibility for oversight and monitoring of compliance with the SoBC and our reported compliance metrics.

Safeguarding human rights

With operations and supply chains in many different diverse and challenging environments around the world, human rights are particularly important for our business and an area we have long focused on addressing.

In recent years, we have been strengthening our approach to further align to the United Nations Guiding Principles on Business and Human Rights (UNGPs). This began with a review of our existing policies and approach to human rights management, informed by an independently-facilitated stakeholder dialogue.

As a result, in 2014, we incorporated our Human Rights Policy into our SoBC. In early 2016, we complemented this with the introduction of our Supplier Code of Conduct, which defines the minimum standards expected of all our suppliers worldwide, including the respect of human rights.

Having established a strong policy base, we have continued to focus in 2017 on enhancing due diligence across our business and supply chains. Arguably, the area of greatest risk is in our tobacco leaf agricultural supply chain, so we have extensive due diligence processes in place, as detailed on pages 27 and 28.

For our non-agricultural supply chain, we have long had due diligence processes in place for strategic direct product materials suppliers.

However, to more closely align with the UNGPs and to better manage supply chain risks and opportunities, we expanded the scope in 2016 to include all our direct materials suppliers, as well as strategic indirect suppliers.

All these suppliers are now assessed according to independent human rights indices and those with the highest risk exposure are prioritised for enhanced due diligence.

In 2017, independent on-site audits were conducted on 65 direct suppliers in 29 countries, representing 20% of our total direct procurement spend. For our indirect suppliers, 102 suppliers in 16 countries were identified as high risk and required to undergo a self-assessment in 2017.

With the majority of our employees working in business areas where we have robust oversight and control, human rights risks in our own operations are substantially avoided. The risks that do exist are also mitigated as a result of the suite of robust policies, practices, compliance and governance procedures that we have in place across all Group companies.

However, we recognise that we need to continually work to ensure these are effectively applied and that we carefully monitor the situation in high-risk countries. So, in 2017, we further strengthened our approach with enhanced monitoring for our operations in countries identified by independent indices as high-risk.

 

LOGO  

 

Further details of our approach to human rights and our Modern Slavery Act statement can be found at www.bat.com/humanrights

Marketing responsibly

We are committed to ensuring all our product marketing complies with local legislation and we have voluntary Marketing Principles in place for our different product categories to govern our approach to responsible marketing to adult consumers only.

In light of our shift to being a multi-category business, we are now developing, as part of NGP integration, a new set of consolidated Marketing Principles to cover all our product categories, including combustible cigarettes, smokeless oral tobacco and NGPs.

In 2017, we revised and strengthened our long-standing approach to youth smoking prevention with the launch of our new Youth Access Prevention (YAP) guidelines. This now covers all our different product categories – from conventional cigarettes to NGPs. We have also broadened the scope to include markets where our products are distributed through third parties, and strengthened the governance process for ensuring compliance.

Reducing our environmental impacts

Our approach to reducing the environmental impacts of our operations is long established. We have a comprehensive Environment, Health and Safety (EHS) management system that is based on international standards, including ISO 14001, and we monitor our Group-wide environmental performance for all BAT sites worldwide.

In 2017, we continued to work towards our long-term target of reducing CO2e emissions by 80% by 2050 against our 2000 baseline and so far have achieved a 46% reduction. See the business measures on page 27 for more details. We use the Greenhouse Gas Protocol Corporate Standard to guide our CO2e reporting methodology (see table below) for defining, consolidating and reporting our Scope 1, Scope 2 and Scope 3 CO2e emissions.

 

LOGO  

 

Further details of our approach to our reporting methodology can be found at www.bat.com/corporatebehaviour/scope

Our focus in 2017 has been on continuing to reduce CO2e emissions and energy use in our factories and in our fleet and logistics, including investing in energy-efficient technologies and switching to low-carbon or renewable energy sources. Our manufacturing processes do not use as much water as many other industries but, with the realities of water scarcity increasingly being felt in some parts of the world, in 2017 we expanded the scope of our water risk assessments to include all our factories and green leaf threshing sites worldwide.

For our tobacco leaf supply chain, environmental criteria form a central part of supplier assessments, as part of the Sustainable Tobacco Programme, and our expert field technicians provide farmers with technical assistance on areas such as sustainable soil, water, biodiversity, and forest and pest management. Our long-running efforts to address deforestation, by eliminating the use of unsustainable sources of wood as a fuel for tobacco curing, has also helped ensure that, in 2017, 99% of farmers’ wood fuel came from sustainable sources.

 

 

 

 

        *  

The 2015 and 2016 data for CO2e emissions and energy use, and 2016 data for water use have been updated. This is broadly due to expanding the scope of recent and historical data to include three sites in one country for completeness and correction of reported volume of MCEs in another site. Additionally, following the implementation of our new reporting system, we have taken steps to improve our calculation methodology, which has resulted in slight adjustments to overall historical data. For details of previously reported figures, see page 35 of our 2017 Sustainability Report, which can be found at www.bat.com/sustainabilityreport

 

Emissions*

 

                   
     

 

2017

 

    

 

2016

 

       

Scope 1 CO2e emissions (tonnes)

     326,242        311,561      

Scope 2 CO2e emissions (tonnes)

     357,645        376,348      

Scope 3 CO2e emissions (tonnes)

     230,017        208,013      

Total (tonnes)

     913,904        895,922     Note: Data from RAI Companies is excluded from this section unless stated otherwise, as we continue the integration.

Intensity (per million cigarettes equivalent)

     0.82        0.84    

 

   
BAT Annual Report and Form 20-F 2017   29


Table of Contents

 

 Strategic Management 

 

                                  

 

Stakeholder engagement

 

 

 

We work with, take into account and respond to the views and concerns of both internal and external stakeholders, adapting to emerging risks and striving to meet the expectations placed upon us as a multinational business.

 

Listening to our stakeholders helps us better understand their views and concerns, and enables us to respond to them appropriately. It gives us valuable inputs to, and feedback on, our strategic approach, as well as our policies, procedures and ways of working. This helps us to continually improve and strengthen them and ensure we are meeting the expectations of our stakeholders.

 

This section provides greater insight into our policies and procedures underpinning the Winning Organisation and Sustainability aspects of our strategy. It also outlines progress against our policy objectives, with a focus on our people and culture, environmental matters, community and social initiatives, respect for human rights, and anti-bribery and corruption, which we know are important considerations for our shareholders and wider stakeholders.

 

We have a number of Group policies and principles in place, including our Standards of Business Conduct (SoBC), that set out our commitments in these areas. These policies and procedures are endorsed by our Board and support the effective identification, management and mitigation of key risks and issues for our business in these and other areas. A summary of our SoBC and other policies in these areas is set out on page 31.

 

All Group companies have adopted the SoBC or localised equivalent. All staff working across the Group are required to complete training, and an annual sign-off, confirming their adherence to the SoBC.

 

 

 
   LOGO    Details of our Group Policies and Principles are available at www.bat.com/principles   LOGO   

Our Speak Up channels, available at www.bat.com/speakup, enable anyone working for, or with, our Group to raise concerns in their local language, in confidence and without fear of reprisal.

 

 

Our ongoing dialogue and engagement with stakeholders – including employees, suppliers, farmers, regulators, local communities and wider society – support our compliance with international standards and evolving regulations, and helps us to understand the issues and challenges our stakeholders face. This enables us to be better placed to co-develop solutions to address issues and challenges.

We engage with regulators around the world to support regulation that is based on robust evidence and thorough research, that respects legal rights and livelihoods, and delivers on intended policy aims, while recognising unintended consequences.

Transparency is crucial to our approach. We are open about what we think, and whether we are in favour of new proposals for regulation or not. Where we may not agree, we always try to be constructive and propose practical alternatives that can still support the achievement of regulatory aims and public health objectives.

We have long recognised the OECD Principles for Transparency and Integrity in Lobbying, and the views and positions that we advocate on key issues are available on our website at bat.com/regulation

We know that, as a responsible company, all engagement activities we undertake must be guided by high standards. These standards are set out in our Principles for Engagement. All Group companies and employees are required to act in accordance with our Principles for Engagement. We support third parties on policy issues of mutual interest, but we will never ask a third party to conduct itself in any way that contravenes these principles.

Our people and culture

We are committed to protecting the safety and wellbeing of our employees, and building a culture where they can develop and thrive. The principal risks for our business in this area relate to the risks of injury, illness or death in the workplace, discussed further as part of our principal Group risk factors on page 53. We also recognise that we must continue to attract and retain the best people, as competition for talented employees intensifies.

Overall responsibility for health and safety is held by the Director, Operations, and the Director, Group Human Resources has overall responsibility for all employee and human resources (HR) matters. Our Management Board oversees the development and management of talent within the Group’s Regions and Functions, and monitors progress against our key objectives and performance indicators.

 

 

 

Our Employment Principles set out a common approach for our Group companies’ policies and procedures, recognising that each Group company must take account of local labour law and practice, and the local political, economic and cultural context. In developing our Employment Principles, we have sought the views of a cross-section of internal and external stakeholders, and have consulted with employee representatives and (where relevant) with our works councils.

All Group companies have committed to our Employment Principles and, through our internal audit processes, are required to demonstrate how these are embedded into the workplace.

Health and safety

Our Health and Safety Policy recognises the importance of the health, safety and welfare of all employees and third party personnel in the conduct of our business operations. We are committed to the prevention of injury and ill-health, and strive for continual improvement in health and safety management and performance. This policy is supported by our Environmental, Health and Safety (EHS) management system, outlined on page 31.

We have a Group-wide goal of zero accidents and our approach to health and safety is based on risk management and assessments, staff training and awareness, and specific initiatives focused on higher risk areas of our business.

Our key performance indicators* in this area include:

 

Lost Workday Case Incident Rate (LWCIR): In 2017, there was an increase in our LWCIR from 0.24 in 2016 to 0.28 in 2017.

 

Lost workday cases (LWC): The number of work-related accidents (including assaults) resulting in injury to employees and to contractors under our direct supervision, causing absence of one shift or more, increased from 155 in 2016, to 181 in 2017.

 

Serious injuries (SI) and fatalities: The total number of serious injuries and fatalities to employees and contractors increased from 56 in 2016 to 74 in 2017.

 

* The 2016 figures related to LWC and SI have been updated to include reportable injuries from 2016 acquisitions. For details of previously reported figures, see page 35 of our 2017 Sustainability Report, which can be found at www.bat.com/sustainabilityreport

Employee development

and engagement

We have a comprehensive Group Talent Strategy in place, focused on attracting, retaining and developing the best talent. This is discussed further on pages 25 and 26.

We undertake a biennial global employee opinion survey (‘Your Voice’) across the Group, which increases employee engagement across the business and helps us continue to improve and update our work environment.

 

 

   
30   BAT Annual Report and Form 20-F 2017


Table of Contents
    

 

Strategic Report

 

       

 

Governance

 

       

 

Financial Statements

 

       

 

Other Information

 

 


 

 

 

Policies / Principles**

 

  

Summary of areas covered

 

  

Key stakeholder groups

 

Standards of Business Conduct (SoBC)   

Anti-bribery and corruption, conflicts of interest, and entertainment and gifts.

Respect in the workplace, including promoting equality and diversity, preventing harassment and bullying, and safeguarding employee wellbeing.

Respect for human rights, including prevention of child labour and exploitation of labour, and respect for freedom of association.

Political contributions and charitable contributions.

Financial integrity, accurate accounting and record-keeping, and information security.

Anti-illicit trade, competition and anti-trust, and sanctions compliance.

Whistleblowing.

  

Employees and contractors

Governments and regulators

Local communities and society

Health and Safety Policy    Health, safety and welfare of all employees, other members of our workforce and third party personnel.   

Employees and contractors

Suppliers, business partners, farmers

Local communities and society

Environment Policy    Our commitments to carrying out our business in an environmentally responsible and sustainable way, including agricultural, manufacturing and distribution operations.   

Employees and contractors

Suppliers, business partners, farmers

Local communities and society

Employment Principles    Employment practices, including commitments to diversity, reasonable working hours, family friendly policies, employee wellbeing, talent, performance and equal opportunities, and fair, clear and competitive remuneration and benefits.    Group employees
Principles for Engagement    Our internal standards guiding all engagement activities, underpinning our commitment to corporate transparency.    Employees and contractors Governments and regulators Local communities and society
Supplier Code of Conduct    Standards required of our suppliers worldwide, including business integrity, anti-bribery and corruption, environmental sustainability and respect for human rights (covering equal opportunities and fair treatment, health and safety, prevention of harassment and bullying, child labour, and exploitation of labour, and freedom of association).   

Suppliers and business partners

Employees and contractors

Local communities and society

Strategic Framework for Corporate Social Investment    Sets out our Group corporate social investment strategy and a framework for our local operating companies to implement that strategy.   

Local communities and society

NGOs and development agencies

 

** Further details of our Group policies and principles can be found at www.bat.com/principles further details of our Strategic Framework for Corporate Social Investment can be found at www.bat.com/csi

 

Our key performance indicators in this area include:

 

Employee retention: In 2017, total turnover of management-grade employees was 1,610, representing 14% of the total management population.

 

Employee engagement: In our 2017 ‘Your Voice’ employee opinion survey, our key Engagement Index score was 83%, 12 percentage points higher than the FMCG comparator norm of 71%.

 

Diversity: Representation of women in senior management roles increased from 16% in 2016, up to 21% in 2017 (2017 data includes RAI Companies).

In addition to our long-standing Employment Principles, we have also adopted a Board Diversity Policy, discussed on page 62, which is specifically applicable to our Board and Management Board.

Environment

We are committed to reducing our environmental impact across our supply chain and operations and our Director, Operations, has overall responsibility for environmental management.

Our Environment Policy applies across all our activities including our supply chain.

The Policy is supported by our comprehensive Environmental, Health and Safety (EHS) management system, which has been in place

for many years and is based on international standards, including ISO 14001.

Each of our Group companies has an EHS Steering Committee, with overall environmental responsibility held by the applicable General Manager or site manager. EHS is also a standing agenda item for management meetings and governance committees at area, regional and global levels. Our governance structures raise awareness of environmental risks across our business and our aim is to create a consistent approach across our Group to manage them.

The primary environmental focus areas for our business include energy use and carbon dioxide (CO2) emissions, water use and availability, and waste and recycling. In our supply chain, the primary focus areas relate to the environmental impacts of tobacco farming.

Our approach to reducing the environmental impacts of our operations is long established and we have an internal reporting system in place for monitoring Group-wide environmental performance. Please refer to pages 27 to 29 for details of our approach to environmental management and progress against key performance indicators.

Community and social initiatives

As an international business, we play an important role in countries around the world and have built close ties with local communities. We encourage our employees

to play an active role both in their local and business communities.

Our Charitable Contributions Policy in our SoBC is supported by the Group Strategic Framework for corporate and social initiatives (CSI), which sets out our Group CSI strategy and how we expect our local operating companies to develop, deliver and monitor community investment programmes within three themes:

 

Sustainable Agriculture and Environment;

 

Empowerment; and

 

Civic Life.

Our Group Head of Sustainability has oversight of the Group CSI Strategy, and Board-level governance is managed through our Audit Committee, which reviews the strategy and an analysis of activities (including investment and alignment to the Group’s priorities) at least once a year.

Our key performance indicator in this area relates to the total amount of money invested in charitable giving and CSI projects. Together with RAI Companies, in 2017 the Group invested a total of £18.7 million in cash, and a further £14.3 million in-kind charitable contributions and CSI projects, including £1.09 million given for charitable purposes in the UK. Much of this investment is delivered through partnerships with external stakeholders including communities, NGOs, governments, development agencies, academic institutions, industry associations and peer companies.

 

 

 

   
BAT Annual Report and Form 20-F 2017   31


Table of Contents

 

 Strategic Management 

 

                                  

Stakeholder engagement continued

 


 

Respect for human rights

The Group has a long-standing commitment to respect fundamental human rights, as affirmed by the Universal Declaration of Human Rights.

The greatest risks for human rights abuses are in our tobacco leaf supply chain which, as with the wider agricultural sector, is recognised by the International Labour Organization to be particularly vulnerable to these risks due to the sheer scale and characteristics such as large numbers of casual and temporary workers, family labour in small-scale farming, and high levels of rural poverty. Human rights challenges in our non-agricultural supply chain depend on the nature of the sector, the type of goods and services supplied, and the country of operation.

With the majority of our employees working in business areas where we have robust oversight and control, human rights risks in our own operations are substantially avoided. The challenges that do exist are mitigated by the suite of robust policies, practices, and compliance and governance procedures that we have in place across all Group companies. However, we recognise that we need to continually work to ensure these are effectively applied and that we carefully monitor the situation, particularly in higher risk countries, such as where regulation or enforcement are weak, or there are high levels of corruption, criminality or unrest.

Our due diligence processes for our business operations and supply chains enable us to monitor the effectiveness of, and compliance with, our Human Rights Policy commitments and our Supplier Code of Conduct, and to identify, prevent and mitigate human rights risks, impacts and abuses. You can read more about these on pages 28 and 29.

In addition to our due diligence work, we developed a new human rights e-learning training package in 2017, targeted at our Procurement and Legal and External Affairs functions, which was completed by over 1,000 managers worldwide. In addition, we delivered training and communications on human rights issues for over 67,000 beneficiaries in rural communities.

Our key performance indicators in this area focus on the number, and results, of reviews and audits conducted as part of our due diligence processes for our suppliers and business operations. In 2017:

 

Independent on-site reviews were conducted on 16 of our tobacco leaf suppliers in 14 countries.

 

Independent audits were conducted on 65 direct materials suppliers in 29 countries.

 

102 indirect suppliers in 16 countries underwent a self-assessment in 2017.

 

BAT business operations in 19 higher risk countries underwent enhanced due diligence to confirm compliance with applicable Group policies, standards and controls, and to provide details of any additional local measures in place to enhance human rights management.

Anti-bribery and corruption

Corrupt practices are illegal, cause distortion in markets and harm economic, social and political development, particularly in developing countries.

Our SoBC makes it clear that it is wholly unacceptable for Group companies, our employees or our business partners to be involved or implicated, in any way, in corrupt practices. Our SoBC is fully aligned with the provisions of the UK Bribery Act and is designed to meet the standards of the OECD Convention on Combating Bribery of Foreign Public Officials in International Business Transactions.

Our policies are continually kept under review and, on the acquisition of RAI in 2017, we updated our SoBC to reflect the requirements of the US Foreign and Corrupt Practices Act, and other relevant US law and regulation. In 2017, we also updated our SoBC to take account of the requirements of the UK Criminal Finances Act.

We also developed a new e-learning course on anti-bribery and corruption in 2017, targeted specifically at employees who conduct external engagement with key stakeholders, governments and regulators. This will be completed by over 3,000 employees in 2018. Alongside this, a new mobile app will be launched in 2018 to provide employees with ‘on-the-go’ guidance on how to act in specific situations.

Our Speak Up channels, discussed on pages 28 and 29, enable anyone working for, or with, our Group to raise any concerns in their local language, in confidence and without fear of reprisal.

Our ‘Delivery with Integrity’ programme discussed on page 28 focused in 2017 on ensuring our policies and training, particularly in relation to anti-bribery and corruption, remain at the forefront of best business practice, on increasing the accessibility of our whistleblowing procedures, and enhancing global oversight of reported issues.

The design of the programme was informed by extensive due diligence on current best practice, including in managing bribery and corruption risks. As part of the programme, we refreshed the Group’s approach to managing potential issues for our business in this area, including:

 

Regulatory engagement activities, guided by the Group’s Principles for Engagement and supported by targeted training to highlight associated risks; and

 

Engagement of third parties as suppliers and consultants to the Group, supported by the deployment of a revised third party due diligence procedure during 2018.

Please refer to pages 69 and 70 for more information about the application of the SoBC in 2017, the Audit Committee’s responsibility for oversight and monitoring of compliance with the SoBC, and our reported compliance metrics.

Note: Data from RAI Companies is excluded from this section unless stated otherwise, as we continue the integration.

 

 

 

   
32   BAT Annual Report and Form 20-F 2017


Table of Contents
                       
 Financial Review         

Strategic Report

 

       

Governance

 

       

Financial Statements    

 

       

Other Information        

 

 

Financial performance summary

 

“The Group continues

to deliver across all

key financial metrics”

 

Ben Stevens

Finance Director

  LOGO   

Highlights

 

–  Group revenue was up 37.6% or 2.9% on an adjusted, organic basis at constant rates of exchange.

 

–  Profit from operations increased by 39.1%, or 3.7% on an adjusted, organic basis at constant rates of exchange.

 

–  Diluted earnings per share up 634%. Adjusted diluted earnings per share up 14.9% or 9.9% at constant rates.

 

–  Dividend per share up 15.2% at 195.2p.

 

–  Net cash generated from operating activities up 16.0%.

 

–  Cash conversion at 83%.

 

 

Non-GAAP measures

In the reporting of financial information, the Group uses certain measures that are not defined by IFRS, the generally accepted accounting principles (‘GAAP’) under which the Group reports. The Group believes that these additional measures, which are used internally, are useful to users of the financial information in helping them understand the underlying business performance.

The principal non-GAAP measures which the Group uses are adjusted revenue, adjusted profit from operations, and adjusted diluted earnings per share. Adjusting items are significant items in revenue, profit from operations, net finance costs, taxation and the Group’s share of the post-tax results of associates and joint ventures which individually or, if of a similar type, in aggregate, are relevant to an understanding of the Group’s underlying financial performance.

As an additional measure to indicate the results of the Group before the impact of exchange rate movements on the Group’s results the movement in adjusted revenue, adjusted profit from operations and adjusted diluted earnings per share are shown at constant rates of exchange.

The Group also includes organic measures of volume, revenue, profit from operations and operating margin to ensure a full understanding of the underlying performance of the Group, before the impact of acquisitions.

These non-GAAP measures are explained on pages 218 to 222.

Revenue

  Revenue

  (£m)

 

LOGO

In 2017, revenue was 37.6% higher at £20,292 million. This was driven by the inclusion of RAI since the acquisition date, pricing, the growth of the NGP portfolio and the translational foreign exchange tailwind on the reported results, partially offset by negative geographic and portfolio mix of 1%. Revenue also grew due to the sale of products bought-in on short-term contract manufacturing arrangements inclusive of excise. After adjusting for the revenue from acquisitions, including RAI, the short-term uplift to revenue due to the treatment of excise on bought-in goods and the effect of exchange on the reported result, on an organic, adjusted constant currency basis, revenue was up by 2.9%.

 

  Change in adjusted revenue

  at constant rates (%)

 

LOGO

Revenue from our NGP portfolio was £397 million, which includes the contribution from RAI brands since the acquisition date. On a 12-month basis, including the full year’s revenue from RAI, revenue from NGPs was approximately £500 million.

In 2016, revenue increased by 12.6%, to £14,751 million driven by price mix of over 6%, and reflecting the positive currency effects resulting from the relative weakness of pound sterling. At constant rates of exchange, revenue would have increased by 6.9% or by 5.3% on an organic basis.

 
 

Reconciliation of revenue to adjusted organic revenue at constant rates

     

 

  

      

2017

£m

    Change
%
    

2016

£m

   

Change

%

    

2015

£m

 
 

 

 
  Revenue      20,292       +38%        14,751       +13%        13,104  
  Adjusting items      (258                  
 

 

 
  Adjusted revenue      20,034       +36%        14,751       +13%        13,104  
  Impact of exchange      (750        (743     
 

 

    
  2016 adjusted revenue at 2015 exchange rates           14,008       +7%     
  2017 adjusted revenue at 2016 exchange rates      19,284       +31%          
 

 

    
  Impact of acquisitions      (4,111        (207     
 

 

    
  Adjusted organic revenue at constant rates      15,173       +3%        13,801       +5%     
 

 

 

 

 

   
BAT Annual Report and Form 20-F 2017   33


Table of Contents

 

 Financial Review 

 

                                  

 

Income statement

 

Profit from operations

(£m)

 

LOGO

Profit from operations grew by 39.1% to £6,476 million and by 2.2% to £4,655 million in 2016. This was driven by the inclusion of RAI during 2017, the improved organic revenue in 2017 and 2016 as described earlier, and the favourable foreign exchange movements, partly offset by the following:

Raw materials and other consumables increased by 19.7% to £4,520 million in 2017, and by 17.4% to £3,777 million in 2016, mainly due to the higher volume and the continued transactional foreign exchange headwinds in both years. This negatively impacted the cost of hard currency denominated items such as leaf and wrapping materials in the operating currencies of our local companies.

Employee benefit costs increased by £405 million to £2,679 million in 2017 and by £235 million to £2,274 million in 2016. The movement was mainly due to the acquisition of RAI in 2017 and the translational foreign exchange movements in 2017 and 2016.

 

Depreciation, amortisation and impairment costs increased by £295 million to £902 million in 2017 and by £179 million in 2016. This was due to the amortisation and impairment charges of £393 million (2016: £166 million, 2015: £72 million) largely related to the trademarks and similar intangibles capitalised following the acquisitions (including RAI, Ten Motives, CHIC Group, TDR, Bentoel, Tekel and Skandinavisk Tobakskompagni A/S (ST)). The increase in 2017 was also driven by higher depreciation charges due to the consolidation of RAI, with depreciation higher in 2016 due to the investment in the Group’s manufacturing infrastructure.

Other operating expenses increased by £1,688 million to £5,346 million in 2017 (2016 up by £386 million) due to the impact of higher overhead costs, foreign exchange in 2017 and 2016 and the acquisition of RAI in 2017.

Expenditure on research and development was approximately £191 million in 2017 (2016: £144 million, 2015: £148 million) with a focus on products that could potentially reduce the risk associated with smoking conventional cigarettes.

Included in profit from operations are a number of adjusting items related to restructuring and integration costs and one-off charges, provisions and income. Adjusted items are defined in note 1 in the Notes on the Accounts.

Total adjusting items were £1,517 million in 2017 (2016: £825 million, 2015: £435 million), including the charges related to trademark amortisation and impairment (discussed above), and £600 million (2016: £603 million,

 

 

Change in adjusted profit from

operations at constant rates (%)

 

LOGO

2015: £367 million) of restructuring and integration costs being mainly in respect of the implementation of the new operating model, integration costs associated with the acquisition of RAI and factory rationalisations. The release of fair value adjustment to inventory (£465 million) and the impairment of certain assets related to Agrokor in Croatia have also been treated as adjusting items.

We call the underlying profit before these items ‘adjusted profit from operations’.

In 2017, adjusted profit from operations at constant rates grew by 39.9% to £7,665 million, driven by the acquisition of RAI. On an organic basis, adjusted profit from operations at constant rates increased by 3.7% (2016: 4.1%). The increase was due to the movement in profit from operations before the impact of adjusting items discussed earlier.

 

 

Analysis of profit from operations, net finance costs and results from associates and joint ventures

 

                                                2017                        2016  
      Reported
£m
   

Adjusting
items

£m

    Adjusted
£m
    Impact of
exchange
£m
    Adjusted
at CC
£m
    Impact of
acquisitions
£m
    Adjusted
organic
at CC
£m
         Reported
£m
   

Adjusting
items

£m

    Adjusted
£m
 

Profit from operations

                      

United States

     1,318       763       2,081       (101     1,980       (1,980                          

Asia-Pacific

     1,638       117       1,755       (81     1,674             1,674         1,432       198       1,630  

Americas

     1,147       109       1,256       32       1,288             1,288         1,017       155       1,172  

Western Europe

     1,127       435       1,562       (104     1,458       (2     1,456         1,044       345       1,389  

EEMEA

     1,246       93       1,339       (74     1,265             1,265           1,182       107       1,289  

Total region

     6,476       1,517       7,993       (328     7,665       (1,982     5,683           4,675       805       5,480  

Non-tobacco litigation:

                      

Fox River

                                                       (20     20        

Profit from operations

     6,476       1,517       7,993       (328     7,665                           4,655       825       5,480  

Net finance (costs)

     (1,094     205       (899     56       (833           (637     108       (529

Associates and joint ventures

     24,209       (23,197     1,012       (61     951                           2,227       (900     1,327  

Profit before tax

     29,591       (21,475     8,116       (333     7,783                           6,245       33       6,278  

 

   
34   BAT Annual Report and Form 20-F 2017


Table of Contents
   

 

Strategic Report

 

      

 

Governance

 

      

 

Financial Statements

 

      

 

Other Information

 

 

 

Operating margin

 

(%)

 

LOGO

Operating margin in 2017 was ahead of 2016 by 30 bps at 31.9%, as the organic performance and inclusion of RAI more than offset the impact of the RAI purchase accounting (mainly on inventory), increased spend related to the NGP portfolio and restructuring and integration costs incurred. The decrease in 2016 was driven by higher restructuring and impairment charges, and transactional foreign exchange headwinds, impacting the Group’s cost of sales.

In 2017, adjusted operating margin increased by 270 bps as the inclusion of RAI, the growth in adjusted organic revenue, driven in part by pricing, and ongoing cost savings (including the US$70 million of synergies achieved), more than offset the impact of inflation and transactional foreign exchange. Adjusted organic operating margin increased by 40 bps. At constant rates, adjusted organic operating margin increased by 30 bps.

In 2016, adjusted operating margin fell by 90 bps as the impact of transactional foreign exchange on cost of sales more than offset the impact of pricing and cost savings across the Group.

 

 

 

 

Adjusted operating margin

(%)

LOGO

Net finance costs

In 2017, net finance costs increased by £457 million to £1,094 million, largely due to the additional finance, including pre-financing charges of £153 million, required to acquire RAI and the finance costs associated with the RAI debt now consolidated within the Group. In 2016, net finance costs were £637 million compared to net finance income of £62 million in 2015. This was principally due to the impact of adjusting items in net finance costs, including one-off costs of £101 million related to the early settlement of a bond (described on page 39), while 2015 included a deemed gain (£601 million) related to the investment in that year in RAI associated with RAI’s acquisition of Lorillard. In 2017 and 2016 the Group recognised interest of £25 million and £25 million respectively in related to FII GLO. 2016 also benefited from an £18 million hedge ineffectiveness gain, which partially reversed in 2017 (£9 million charge), following the market volatility due to Brexit, which is not in the normal course of business.

 

 

Net finance costs before the impact of the adjusting items described above, and at constant rates of exchange, were £833 million an increase of 57.5% on 2016, which were 15.7% higher than 2015 at £427 million. The Group’s average cost of debt in 2017 was 3.3%, ahead of 3.1% achieved in both 2016 and 2015.

Associates and joint ventures

Associates in 2017 principally comprised RAI (for the period prior to the acquisition in July 2017 of the shares in RAI not already owned by the Group) and ITC. The Group’s share of the post-tax results of associates and joint ventures, included at the pre-tax profit level under IFRS, increased by £21,982 million to £24,209 million, due to a gain of £23,288 million arising on the deemed disposal of RAI as an associate as, following the acquisition, RAI is consolidated as a wholly owned subsidiary.

In 2016, the Group’s share of post-tax results from associates and joint ventures increased by £991 million, to £2,227 million, largely due to a gain of £900 million recognised in 2016 which mainly related to the sale by RAI of the international rights to Natural American Spirit.

Excluding the effect of the gain noted above and other adjusting items, the Group’s share of associates and joint ventures on an adjusted, constant currency basis fell in 2017 by £951 million or 28.3% due to RAI’s contribution as an associate for only part of the year, while the Group’s share of ITC’s post-tax results grew by 16.7%. In 2016, the Group’s share of results of associates and joint ventures on an adjusted constant currency basis increased by 26.2%, driven by RAI, up 35% partly due to a full year’s contribution from Lorillard and ITC, higher by 7%.

 

 

Analysis of profit from operations, net finance costs and results from associates and joint ventures

 

                                                2016                        2015  
      Reported
£m
   

Adjusting
items

£m

    Adjusted
£m
    Impact of
exchange
£m
    Adjusted
at CC
£m
    Impact of
acquisitions
£m
    Adjusted
organic
at CC
£m
         Reported
£m
   

Adjusting
items

£m

    Adjusted
£m
 

Profit from operations

                      

Asia-Pacific

     1,432       198       1,630       (142     1,488             1,488         1,361       108       1,469  

Americas

     1,017       155       1,172       30       1,202             1,202         1,082       87       1,169  

Western Europe

     1,044       345       1,389       (153     1,236       (11     1,225         990       156       1,146  

EEMEA

     1,182       107       1,289       (18     1,271       (12     1,259           1,127       81       1,208  

Total region

     4,675       805       5,480       (283     5,197       (23     5,174           4,560       432       4,992  

Non-tobacco litigation:

                      

Fox River / Flintkote

     (20     20                                             (3     3        

Profit from operations

     4,655       825       5,480       (283     5,197                           4,557       435       4,992  

Net finance (costs) / income

     (637     108       (529     35       (494           62       (489     (427

Associates and joint ventures

     2,227       (900     1,327       (137     1,190                           1,236       (293     943  

Profit before tax

     6,245       33       6,278       (385     5,893                           5,855       (347     5,508  

 

   
BAT Annual Report and Form 20-F 2017   35


Table of Contents

 

 Financial Review 

 

 

    
     

Income statement continued

 

 

Tax

In 2017, the tax charge in the Income Statement was a credit of £8,113 million, against a charge of £1,406 million in 2016 and £1,333 million in 2015. The 2017 credit was largely due to the impact of the change in tax rates in the United States which led to a credit of £9.6 billion related to the revaluation of deferred tax liabilities arising on the acquired net assets of RAI, and described below. The tax rates in the Income Statement are therefore a credit of 27.4% in 2017, against a charge of 22.5% in 2016 and 22.8% in 2015. These are also affected by the inclusion of adjusting items described earlier and the associates and joint ventures’ post-tax profit in the Group’s pre-tax results. Excluding these items and the deferred tax credit in 2017, the underlying tax rate for subsidiaries was 29.7% in 2017 (2016: 29.8% and 2015: 30.5%). See the section Non-GAAP measures on page 220 for the computation of underlying tax rate for the periods presented.

Tax strategy

The Group’s global tax strategy is reviewed regularly by the Board. The operation of the strategy is managed by the Finance Director and Group Head of Corporate Tax with the Group’s tax position reported to the Audit Committee on a regular basis. The Board considers tax risks that may arise as a result of our business operations. In summary, the strategy includes:

 

complying with all applicable laws and regulations in countries in which we operate;

 

being open and transparent with tax authorities and operate to build mature professional relationships;

 

supporting the business strategy of the Group by undertaking efficient management of our tax affairs in line with the Group’s commercial activity;

 

transacting on an arm’s length basis for exchanges of goods and services between companies within the Group; and

 

engaging in proactive discussions with tax authorities on occasions of differing legal interpretation.

The publication of this strategy is considered to constitute compliance with the duty under paragraph 16(c) Schedule 19 Part 2 of the UK Finance Act 2016.

The taxation on ordinary activities for 2017 was a credit of £8.1 billion against a charge of £1.4 billion in 2016 and £1.3 billion in 2015, with tax paid (due to the timing of corporation tax instalment payments which straddle different financial years) of £1.7 billion (2016: £1.2 billion, 2015: £1.3 billion).

Our tax footprint extends beyond corporation tax, including significant payment of employment taxes and other indirect taxes including customs and import duties. The Group also collects taxes on behalf of governments (including tobacco excise, employee taxes, VAT and other sales taxes). The total tax contribution in 2017 of £37.4 billion (2016: £33.2 billion, 2015: £29.6 billion) therefore consists of both taxes borne and taxes collected as shown in the table provided.

In addition to the major taxes, there are a host of other taxes the Group bears and collects such as transport taxes, energy and environmental taxes, and banking and insurance taxes.

As part of the acquisition of RAI, the Group acquired the assets and liabilities of the RAI Companies. These are required to be fair valued at the date of acquisition, as disclosed in note 24 on the accounts, on page 165. The value of the net assets acquired created a deferred tax liability, valued within the purchase price allocation process at the prevailing rate of corporation tax at the date of acquisition, being 25 July 2017. Subsequently, on 22 December 2017, the US federal corporate tax rate was changed to 21%, effective from 1 January 2018. This revised rate has been used to value the deferred tax liability at the balance sheet date, reducing the liability and providing a credit to the income statement in 2017 of £9.6 billion. Due to the scale of the impact, this credit has been treated as an adjusting item.

Major taxes paid 2017
(£bn)

 

LOGO

Major taxes paid

 

           2017      2016  
         £bn      £bn  

 

 
    Tobacco excise (collected)      29.0        25.9  
    Net VAT and other sales      
    taxes (collected)      5.9        5.2  
    Corporation tax (borne)      1.7        1.2  
    Customs and import duties      
  (borne)      0.2        0.4  
    Taxes paid by employee      
  (collected)      0.4        0.3  
    Employment taxes (borne)      0.2        0.2  
                       
           37.4      33.2  

 

The movements in deferred tax, taken through other comprehensive income, mainly relate to the change in the valuation of pensions in the year, as disclosed in note 13 in the Notes on the Accounts.

 

Where resolution is not possible, tax disputes may proceed to litigation. The Group seeks to establish strong tax technical positions. Where legislative uncertainty exists, resulting in differing interpretations, the Group seeks to establish that its position would be more likely than not to prevail. Transactions between Group subsidiaries are conducted on arm’s length terms in accordance with appropriate transfer pricing rules and OECD principles.

 

The tax strategy outlined above is applicable to all Group companies, including the UK Group; referene to tax authorities includes HMRC.

 

Deferred tax asset / (liability)

 

 

       

2017

£m

    2016
£m
    2015
£m
 
  Opening balance      (216     (237     (184
  Difference on exchange      852       (39     (4
  Recognised on acquisition of RAI      (27,065            
  Impact of US tax reforms      9,620              
  Other (charges) / credits to the income statement      136       (4     (4
  Other (charges) / credits to other comprehensive income      (133     70       (9
  Other movements      (6     (6     (36
  Closing balance        (16,812         (216         (237
        
        
        

 

   
36   BAT Annual Report and Form 20-F 2017


Table of Contents
    

 

Strategic Report

 

       

 

Governance

 

       

 

Financial Statements

 

       

 

Other Information

 

 

 

 


Diluted earnings per share (EPS)

(p)

 

LOGO

 

Change in adjusted diluted EPS

(%)

 

LOGO

 

Change in adjusted diluted EPS at constant rates (%)

 

LOGO

Earnings per share

Basic earnings per share were 634% higher at 1,836.3p (2016: 250.2p, up 8.4%, 2015: 230.9p) with the growth in 2017 benefiting from the movements related to the acquisition of RAI in the year and the impact of the US tax reform. 2016 was higher than 2015 due to growth in profit from operations and an increased contribution from RAI following the acquisition of Lorillard. After accounting for the dilutive effect of employee share schemes, diluted earnings per share were 634% higher than 2016 at 1,830.0p (2016: 249.2p, 2015: 230.3p).

Earnings per share are impacted by the adjusting items discussed earlier. Adjusted diluted EPS, as calculated in note 7 in the Notes on the Accounts, was up against the prior year by 14.9%, with 2016 ahead of 2015 by 18.8% at 247.5p. Adjusted diluted EPS at constant rates would have been 9.9% ahead of 2016 at 272.1p, with 2016 up 10.4% against 2015.

Dividends

On 26 April 2017, the Group announced its move to quarterly dividends with effect from 1 January 2018. Quarterly dividends will provide shareholders with a more regular flow of dividend income and will allow the Company to spread its substantial dividend payments more evenly over the year. The dividends will align better with the cash flow generation of the Group and so enable the Company to fund the payments more efficiently.

The Board has declared an interim dividend of 195.2p per ordinary share of 25p, payable in four equal quarterly instalments of 48.8p per ordinary share in May 2018, August 2018, November 2018 and February 2019. This represents an increase of 15.2% on 2016, (2016: 169.4p per share), and a payout ratio, on 2017 adjusted diluted earnings per share, of 69%.

As part of the transition to quarterly dividend payments, the Group committed that shareholders would receive the equivalent amount of total cash payment in 2018 as they would have under the previous payment policy.

Based upon 65% of 2017 earnings, under the previous calculation methodology, shareholders would have expected to receive a final dividend of 128.4p in May 2018 and an interim dividend of 61.6p in September 2018, being equivalent to one third of the dividend in respect of 2017, with total dividend expected to be received in 2018 of 190.0p.

A second interim dividend of 43.6p (equivalent to 25% of the cash dividend paid in 2017) was announced on 5 December 2017 and was paid on 8 February 2018. This second interim dividend and the three quarterly dividend amounts payable in the calendar year 2018 (May, August and November), ensure that shareholders receive the equivalent cash amount during the year as they would have under the previous payment policy.

The quarterly dividends will be paid to shareholders registered on either the UK main register or the South Africa branch register and to ADS holders, each on the applicable record dates.

Under IFRS, the dividend is recognised in the year that it is declared or, if required, approved by shareholders. Therefore, the 2017 accounts reflect the 2016 final dividend (approved in April 2017), the 2017 interim dividend (approved in July 2017) and the second 2017 interim dividend (approved in December 2017), in total amounting to 218.2p (£4,465 million), against 155.9p (£2,910 million) in 2016. Further details of the total amounts of dividends paid in 2017 (with 2016 comparatives) are given in note 8 in the Notes on the Accounts.

Dividends are declared and payable in sterling except for those shareholders on the branch register in South Africa, where dividends are payable in rand. The equivalent dividends receivable by holders of ADSs in US dollars are calculated based on the exchange rate on the applicable payment date.

Further details of the quarterly dividends and key dates are set out under ‘Shareholder information’ on page 242.

 

 

   
BAT Annual Report and Form 20-F 2017   37


Table of Contents

 

 Financial Review 

 

                                  

 

Treasury and cash flow

 

Treasury, liquidity and capital structure

The Treasury function is responsible for raising finance for the Group, managing the Group’s cash resources and managing the financial risks arising from underlying operations. Clear parameters have been established, including levels of authority, on the type and use of financial instruments to manage the financial risks facing the Group. Such instruments are only used if they relate to an underlying exposure; speculative transactions are expressly forbidden under the Group’s treasury policy. All these activities are carried out under defined policies, procedures and limits, reviewed and approved by the Board, delegating oversight to the Finance Director and Treasury function. See note 23 in the Notes on the Accounts for further detail.

It is the policy of the Group to maximise financial flexibility and minimise refinancing risk by issuing debt with a range of maturities, generally matching the projected cash flows of the Group and obtaining this financing from a wide range of providers. The Group targets an average centrally managed debt maturity of at least five years with no more than 20% of centrally managed debt maturing in a single rolling year. As at 31 December 2017, the average centrally managed debt maturity was 9.2 years (2016: 8.2 years, 2015: 7.9 years) and the highest proportion of centrally managed debt maturing in a single rolling 12-month period was 13.2% (2016: 18.1%, 2015: 15.0%).

The only externally imposed capital requirement the Group has is in respect of its centrally managed banking facilities, which require a gross interest cover of 4.5 times. The Group targets a gross interest cover, as calculated under its key central banking facilities, of greater than 5 times. For 2017, it is 7.8 times (2016: 12.2 times, 2015: 11.6 times).

The Group continues to maintain investment-grade credit ratings, with ratings from Moody’s/S&P at Baa2 (stable outlook)/BBB+ (stable outlook), respectively. The strength of the ratings has underpinned debt issuance and the Group is confident of its ability to successfully access the debt capital markets. All contractual borrowing covenants have been met and none are expected to inhibit the Group’s operations or funding plans.

The Group replaced the existing £3 billion revolving credit facility maturing in 2021 with a new two-tranche £6 billion revolving credit facility. This consists of a 364-day revolving credit facility of £3 billion (with a one-year extension and a one-year term out option), and a £3 billion revolving credit facility maturing in 2021. The Group also increased the EMTN programme from £15 billion to £25 billion and increased its US and European commercial paper programmes from US$3 billion to US$4 billion and from £1 billion to £3 billion, respectively, to accommodate the liquidity needs of the enlarged Group. At 31 December 2017, £600 million was drawn within the revolving credit facility (2016: undrawn) with £1.2 billion of commercial paper outstanding (2016: £254 million, 2015: £505 million), due to short term funding of the payment of the 2017 MSA liability.

Management believes that the Group has sufficient working capital for present requirements, taking into account the amounts of undrawn borrowing facilities and levels of cash and cash equivalents, and the ongoing ability to generate cash.

On 25 July 2017, British American Tobacco p.l.c. acceded as guarantor under the indentures of its indirect wholly owned subsidiaries RAI and R.J. Reynolds Tobacco Company. The securities issued under these indentures include approximately US$12.2 billion aggregate principal amount of unsecured RAI debt securities and approximately US$231 million aggregate principal amount of unsecured R.J. Reynolds Tobacco Company securities.

Cash flow

Net cash generated from operating activities

Net cash generated from operating activities increased in 2017 by £737 million (or 16.0%) largely due to the cash generated by RAI from 25 July 2017, the profit from operations earned in the period from the rest of the Group (as discussed on pages 44 to 47) and a reduction in inventories. This more than offset an increase in receivables, reduction in trade and other payables, the payment of the 2017 liability related to the MSA in the US and the final quarterly payments in relation to the Quebec Class Action.

In 2016, net cash generated from operating activities decreased by £110 million to £4,610 million, principally due to the Franked Investment Income Group Litigation Order receipts (FII GLO) of £963 million in 2015 that did not recur in 2016 and the continued payments on the Quebec Class Action.

Net cash used in investing activities

In 2017, net cash used in investing activities increased by £17,904 million to £18,544 million (2016: £640 million, 2015: £3,991 million) principally due to the acquisition of the shares in RAI not already owned by the Group. In 2016, cash outflows from investing activities mainly related to the acquisition of Ten Motives, and were lower than 2015, during which year the Group invested to maintain its shareholding in RAI during RAI’s acquisition of Lorillard and completed a number of other acquisitions including TDR.

Included within investing activities is gross capital expenditure which includes purchases of property, plant and equipment and purchases of intangibles. This includes the investment in the Group’s global operational infrastructure (including, but not limited to, the manufacturing network, trade marketing and IT systems). In 2017, the Group invested £862 million, an increase of 32.2% on the prior year (2016: £652 million, 2015: £591 million). The Group expects gross capital expenditure in 2018 of £1,075 million, mainly related to the ongoing investment in the Group’s operational infrastructure including the expansion of NGP.

 

 

   
38   BAT Annual Report and Form 20-F 2017


Table of Contents
    

 

Strategic Report

 

       

 

Governance

 

       

 

Financial Statements

 

       

 

Other Information

 

 

 

Summary cash flow

 

     

 

2017

    2016     2015  
     

£m

 

   

£m

 

   

£m

 

 

 

Cash generated from operations

 

    

 

6,119

 

 

 

   

 

4,893

 

 

 

   

 

5,400

 

 

 

Dividends received from associates

 

    

 

903

 

 

 

   

 

962

 

 

 

   

 

593

 

 

 

Tax paid

 

    

 

(1,675

 

 

   

 

(1,245

 

 

   

 

(1,273

 

 

 

Net cash generated from operating activities

 

    

 

5,347

 

 

 

   

 

4,610

 

 

 

   

 

4,720

 

 

 

Net cash used in investing activities

 

    

 

(18,544

 

 

   

 

(640

 

 

   

 

(3,991

 

 

Net cash used in financing activities

 

    

 

14,759

 

 

 

   

 

(4,229

 

 

   

 

(219

 

 

Differences on exchange

 

    

 

(391

 

 

   

 

180

 

 

 

   

 

(272

 

 

 

Increase / (Decrease) in net cash and cash equivalents

 

    

 

1,171

 

 

 

   

 

(79

 

 

   

 

238

 

 

 

 

Net cash used in financing activities

In 2017, net cash used in financing activities was an inflow of £14,759 million, against an outflow of £4,229 million in 2016 and £219 million in 2015. The increase in cash flows in 2017 were mainly due to the debt movements below, largely the result of the financing undertaken in respect of the acquisition of RAI, partly offset by the payment of the dividend. The increase in outflows in 2016 was largely attributable to a reduction in cash inflows from borrowings of £3,445 million in 2016.

Dividends paid in 2017 increased to £3,465 million compared to £2,910 million in 2016 and £2,770 million in 2015. The increase in 2017 was due to the increased dividend per share and the higher number of shares in issue following the acquisition of RAI.

In March 2016, a US$300 million bond was repaid on maturity. In July 2016, the Group issued a £500 million bond maturing in 2021, and issued two bonds in September 2016 (a US$650 million bond maturing in 2019 and a £650 million bond maturing in 2052). The Group repaid on maturity a CHF 350 million bond in August 2016 and a £325 million bond in September 2016. On 19 July 2016, the Group exercised the make-whole provision for its US$700 million bond originally issued in 2008 pursuant to Rule 144A. The bond was redeemed on 18 August 2016, prior to its original maturity date of 15 November 2018.

In March and April 2017, the Group arranged short term bilateral facilities with some of its core banks for a total of approximately £1.6 billion equivalent. In June 2017, a 1,250 million bond and a US$600 million bond were repaid at maturity. In August 2017, the Group paid on maturity a US$500 million bond.

In July 2017, following the shareholder approvals of the acquisition of RAI, the Group used its US$25 billion acquisition facility provided by a syndicate of relationship banks comprising US$15 billion and US$5 billion bridge facilities with one-and two-year maturities, respectively. In addition, the acquisition facility included two $2.5 billion term loans with maturity in 2020 and 2022. In August 2017, the bridge facilities were refinanced in the US and European capital markets.

Eight US dollar denominated bonds were issued pursuant to Rule 144A with registration rights totalling US$17.25 billion. The issue comprised two bonds totalling US$3.25 billion maturing in August 2020, two bonds totalling US$3 billion maturing in August 2022, one US$2.5 billion bond maturing in August 2024, one US$3.5 billion bond maturing in August 2027, one US$2.5 billion bond maturing in August 2037 and one US$2.5 billion bond maturing in August 2047.

 

During 2017, four series of bonds were issued pursuant to the EMTN programme and comprised a £450 million bond maturing in August 2025 and three euro denominated bonds totalling 3.1 billion comprising a 1.1 billion bond maturing in August 2021, a 750 million bond maturing in November 2023 and a 1.25 billion bond maturing in January 2030.

Cash flow conversion

The conversion of profit from operations to net cash generated from operating activities may indicate the Group’s ability to generate cash from the profits earned. Based upon net cash generated from operating activities, the Group’s conversion rate decreased from 99% to 83% in 2017. This was largely due to the timing of the payment in relation to the 2017 liability for the MSA in December 2017, the costs associated with the acquisition of RAI and other adjusting items.

 

 

   
BAT Annual Report and Form 20-F 2017   39


Table of Contents

 

 Financial Review 

 

                                  

Cash flow continued

 

 

Borrowings and net debt

Total borrowings increased to £49,450 million in 2017 (2016: £19,495 million; 2015: £17,001 million), largely due to the US$25 billion debt raised in connection with the acquisition of the remaining 57.8% of shares in RAI not previously owned by the Group and the consolidation of RAI’s debt on acquisition (US$13 billion). Borrowings increased in 2016 partly due to the issuance of GBP and US dollar bonds and the impact of devaluation of sterling on the year end balances.

Net debt is a non-GAAP measure and is defined as total borrowings, including related derivatives, less cash and cash equivalents and current available-for-sale investments. Net debt at 31 December 2017 was £45,571 million (2016: £16,767 million; 2015: £14,794 million), with the movement in net debt in 2017 and 2016 largely due to the movement in borrowings, described above.

 

Retirement benefit schemes

The Group’s subsidiaries operate around 190 retirement benefit arrangements worldwide. The majority of the scheme members belong to defined benefit schemes, most of which are funded externally and many of which are closed to new entrants.

The Group also operates a number of defined contribution schemes. The present total value of funded scheme liabilities as at 31 December 2017 was £11,868 million (2016: £7,155 million; 2015: £5,956 million), while unfunded scheme liabilities amounted to £1,157 million (2016: £476 million; 2015: £364 million). The schemes’ assets increased from £6,086 million in 2015 to £7,278 million in 2016 and to £12,350 million in 2017. After excluding unrecognised scheme surpluses of £23 million (2016: £18 million; 2015: £11 million), the overall net liability for all pension and health care schemes in Group subsidiaries amounted to £698 million at the end of 2017, compared to £371 million at the end of 2016 (2015: £245 million). Contributions to the defined benefit schemes are determined after consultation with the respective trustees and actuaries of the individual externally funded schemes, taking into account regulatory environments.

 

Accounting policies

The application of the accounting standards and the accounting policies adopted by the Group are set out in the Group Manual of Accounting Policies and Procedures (GMAPP).

GMAPP includes the Group instructions in respect of the accounting and reporting of business activities, such as revenue recognition, asset valuations and impairment testing, adjusting items, the accrual of obligations and the appraisal of contingent liabilities, which include taxes and litigation. Formal processes are in place whereby central management and end-market management confirm adherence to the principles and the procedures and to the completeness of reporting. Central analyses and revision of information are also performed to ensure and confirm adherence.

In order to prepare the Group’s consolidated financial information in accordance with IFRS, management has used estimates and assumptions that affect the reported amounts of revenue, expenses, assets and the disclosure of contingent liabilities at the date of the financial statements.

The critical accounting estimates are described in note 1 in the Notes on the Accounts and include:

 

review of asset values, including goodwill and impairment testing;

 

estimation and accounting for retirement benefit costs;

 

estimation of provisions, including as related to taxation and legal matters; and

 

estimation of the fair values of acquired net assets arising in a business combination.

The critical accounting judgements are described in note 1 on the financial statements and include;

 

identification and quantification of adjusting items; and

 

review of applicable exchange rates for transactions with and translation of entities in territories where there are restrictions on the free access to foreign currency or multiple exchange rates.
 
Reconciliation of total borrowings to net debt       
     

 

2017

    2016     2015  
     

£m

 

   

£m

 

   

£m

 

 

 

Total borrowings*

     49,450