> Consumer Deutsche Bank 0 BAT — Gerry Gallagher, BUY, close 4914p, 6000p tgt, 22% upside ■ BAT offers 50% TSR over the next two years, only 15ppts of which is from an EV re-rating. ■ Its broad offering in next generation products (NGP), both in heat-not- burn and vaping, puts BAT at a competitive advantage could fuel group organic growth of c5% organic growth FY18 and c6% FY19. it BAT is one of the fastest growing large cap European staples yet it trades at a discount to the European sector and its international peers. ■ Key drivers: - Strong organic EBITDA growth and debt pay down (c28ppts). EBITDA growth could fuel 10% pa EPS growth, while debt pay-down further shifts the EV to equity. - Attractive dividend (c7ppts upside over next two years). - Re-rating to 13.1x 18E EV/EBITDA (c15ppts upside) and still at a discount to staples and international peers. Concerns regarding potential plans by the FDA to reduce cigarettes' nicotine content (announced in July 2017) have brought the multiple down to 12.4x. - The FDA regulatory process takes many years. By its conclusion, NGPs may already be well-established. ■ Catalysts: US tax reform (could add 5-8% to EPS); FY17 results end Feb; FDA comments through 2018 Related DB Research: What's going on (Gallagher) You can't have your cake and eat it (Gallauherl We see potential for 50% TSR over the next two years Operational drivers: 27.8% EV/EBITDA remains at 12.3x 1.3% 0% 10% 20% • EBITDA (operational) growth Assoc. and rams. • Incremental EPS at higher PIE multiple Source: Deutsche Bank eslimales: assumes 10% EPS growth Re-rating 14 8% 12 0% 7.4% 30% 40% • Debt paydown • PIE expansion ex operational drivers DPS 50% Operational drivers are key— we see substantial EBITDA growth to come 16 14 1 12 1 10 1 8 6 41 2j EBITDA (GBPbn) (LHS) FY19 FY20 FY17 FY18 Source: Deulsche Bank estimates: assumes 10% EPS growth Growth (RHS) 40% 35% 30% 25% 20% 15% 10% 5% 0% Deu