Annual Financial Report

RNS Number : 1958Z

British American Tobacco PLC

13 March 2017

BRITISH AMERICAN TOBACCO p.l.c.

Annual Report for the Year Ended 31 December 2016

In compliance with Listing Rule 9.6.1, British American Tobacco p.l.c. (the "Company") reports that its Annual Report 2016 (including the Strategic Report 2016) will be shortly submitted to the National Storage Mechanism and will be available for inspection via the following link: www.morningstar.co.uk/uk/nsm.

The Company's Annual Report 2016 has been published to be viewed or downloaded on the British American Tobacco website www.bat.com/annualreport.

The Annual Report 2016 and other ancillary shareholder documents will be mailed and made available to shareholders on 23 March 2017.

The Company made its Preliminary Announcement of its audited results (which included a Directors' responsibility statement) in respect of the year ended 31 December 2016 (the "Preliminary Announcement") on 23 February 2017. Further to the Preliminary Announcement and with reference to the requirements of Rules 4.1 and 6.3.5 of the Disclosure Guidance and Transparency Rules, the following disclosures are made in the Appendices below.

Appendix A to this announcement contains a description of the Principal Group risk factors (page 26 of the Annual Report 2016) and Appendix B is a statement of related party disclosures (page 140 Annual Report 2016). Together these constitute the material required by Rule 6.3.5 of the Disclosure Guidance and Transparency Rules to be communicated to the media in unedited full text through a Regulatory Information Service. This material is not a substitute for reading the full Annual Report 2016. Any page numbers and cross-references in the extracted information below refer to page numbers in the Annual Report 2016.

G C W Cunnington

Deputy Secretary

13 March 2017

Enquiries:

Investor Relations

Mike Nightingale/Rachael Brierley/Sabina Marshman

+44 20 7845 1180/1519/1781

British American Tobacco Press Office

Anna Vickerstaff

+44 20 7845 2888

APPENDIX A

PRINCIPAL GROUP RISK FACTORS

Overview

The principal risk factors that may affect the Group are set out on the following pages.

Each risk is considered in the context of the Group's strategy, as set out in [the] Strategic Report on page 6. Following a description of each risk, its potential impact and mitigation for the Group is summarised. Clear accountability is attached to each risk through the risk owner.

The Group has identified and is actively monitoring and taking action to mitigate the risks. This section focuses on those risks that the Directors believe to be the most important after assessment of the likelihood and potential impact on the business. Not all of these risks are within the control of the Group and other factors besides those listed may affect the Group's performance. Some risks may be unknown at present. Other risks, currently regarded as less material, could become material in the future.

The risk factors listed in this section and the activities being undertaken to mitigate them should be considered in the context of the Group's internal control framework. This is described in the section on risk management and internal control in the corporate governance statement on page 44. This section should also be read in the context of the cautionary statement set out below.

Assessment of Group risk

During the year, the Directors have carried out a robust assessment of the principal risks and uncertainties facing the Group, including those that would threaten its business model, future performance, solvency or liquidity.

The principal risks facing the Group have remained broadly unchanged over the past year, particularly with regard to the principal risks included in Marketplace, Excise and Tax, Operations, Regulation and Litigation risk factors. The Board has considered the risks associated with the inability to recruit required talent and the loss of existing talent. The impact and likelihood of the risk has decreased and it is no longer a principal risk.

The viability statement below provides a broader assessment of long-term solvency and liquidity, the statement being forward-looking. The Directors have considered a number of factors that may affect the resilience of the Group, including some of the principal risks that may impact the Group's viability. This is indicated in the 'impact on viability statement' key under each risk.

Cautionary statement

The Strategic Report and certain other sections of [the] Annual Report contain forward-looking statements that are subject to risk factors associated with, among other things, the economic and business circumstances occurring from time to time in the countries and markets in which the Group operates. It is believed that the expectations reflected in these statements are reasonable but they may be affected by a wide range of variables that could cause actual results to differ materially from those currently anticipated.

Viability Statement

The Directors have assessed the viability of the Group, in accordance with provision C.2.2 of the 2016 revision of the UK Corporate Governance Code. In making this assessment the Directors have considered the Group's continued strong cash generation from operating activities and the impact of the proposal to acquire the shares in Reynolds American not already owned by the Group, as this will increase the Group's net debt. This assessment included a robust review of the principal risks that may impact the Group's viability (as indicated on pages 27-30) which are considered, with the mitigating actions, at least once a year. The Directors also took account of the Group's operational and financial processes, which cover both short term (1-2 year financial forecasts, 2-3 year capacity plans) and longer term strategic planning. The assessment included reverse stress testing core drivers that underpin the specific risks to ensure the business is able to continue in operation, whilst not breaching the required gross interest cover of 4.5 times (see page 23). Each impact would, individually, have to be between 5x and 17x worse than a prudent annual forecast. If all risks arose simultaneously the Group would continue to be able to meet the liabilities as they fall due.

The Directors noted that the Group would be able to adjust certain capital requirements, including but not limited to the investment in the Group's manufacturing infrastructure in the short term and the £3 billion credit facility (2016: undrawn), to mitigate the impact of the effect of the above principal risks, each of which have specific mitigation activities as disclosed on pages 27-30.

The Group operates in a unique environment, being subject to inherent uncertainties with regards to regulatory change and litigation, the outcome of which may have a bearing on the Group's viability. The Group maintains, as referred to in note 28 "Contingent Liabilities and Financial Commitments" [on the Notes on the Accounts to the Annual Report] , that, whilst it is impossible to be certain of the outcome of any particular case, the defences of the Group's companies to all the various claims are meritorious on both law and the facts. If an adverse judgment is entered against any of the Group's companies in any case, an appeal will be made, the duration of which can be reasonably expected to last for a number of years.

The Directors have no reason to believe the Group will not be viable over a longer period. However, given the inherent uncertainty involved regarding litigation and regulation, the period over which the Directors consider it possible to form a reasonable expectation as to the Group's longer term viability, based on the stress testing and scenario planning discussed above, is three years.

Risks

Competition from illicit trade

Increased competition from illicit trade - either local duty evaded, smuggled illicit white cigarettes or counterfeits.

Time frame

Long term

Strategic impact

Growth

Considered in viability statement

Yes

Impact

Erosion of brand value, with lower volumes and reduced profits.

Reduced ability to take price increases.

Investment in trade marketing and distribution is undermined.

Mitigation activities

Dedicated Anti-Illicit Trade (AIT) teams operating at global, country levels and internal cross-functional coordination; best practice shared.

Active engagement with key external stakeholders.

Cross-industry and multi-sector cooperation on a range of AIT issues.

Global AIT strategy supported by a research programme to further the understanding of the size and scope of the problem.

AIT Engagement Team (including a dedicated analytical laboratory) works with enforcement agencies in pursuit of priority targets.

Tobacco regulation inhibits growth strategy

The enactment of unreasonable regulation that prohibits the Group's ability to communicate with consumers, differentiate our products and launch future products.

Time frame

Medium term

Strategic impact

Growth and Sustainability

Considered in viability statement

Yes

Impact

Erosion of brand value through commoditisation, the inability to launch innovations, differentiate products, maintain or build brand equity and leverage price.

Adverse impact on ability to compete within the legitimate tobacco industry and also with increased illicit trade.

Reduced consumer acceptability of new product specifications, leading to consumers seeking alternatives in illicit trade.

Shocks to share price on enactment of unduly onerous and restrictive regulation.

Reduced ability to compete in future product categories and make new market entries.

Increased scope and severity of compliance regimes in new regulation leading to higher costs, greater complexity and potential reputational damage or fines for inadvertent breach.

Mitigation activities

Engagement and litigation strategy coordinated and aligned across the Group to drive a balanced global policy framework for tobacco control.

Stakeholder mapping and prioritisation, developing robust compelling advocacy materials (with supporting evidence and data) and regulatory engagement programmes.

Regulatory risk assessment of marketing plans to ensure decisions are informed by an understanding of the potential regulatory environments.

Advocating the application of our integrated regulatory proposals to governments and public health practitioners based on the harm reduction principles.

Development of an integrated regulatory strategy that spans conventional combustibles and includes Next Generation Products.

Significant excise increases or structure changes

The Group is exposed to unexpected and/or significant excise increases or structure changes in key markets.

Time frame

Long term

Strategic impact

Growth

Considered in viability statement

Yes

Impact

Consumers reject the Group's legitimate tax-paid products for products from illicit sources or cheaper alternatives.

Reduced legal industry volumes.

Reduced sales volume and/or portfolio erosion.

Some absorption of excise increases.

Mitigation activities

Requirement for Group companies to have in place formal pricing and excise strategies including contingency plans, with annual risk assessments.

Pricing, excise and trade margin committees in markets, with regional and global support.

Engagement with local tax and customs authorities, where appropriate, in particular in relation to the increased risk to excise revenues from higher illicit trade.

Portfolio reviews to ensure appropriate balance and coverage across price segments.

Monitoring of economic indicators, government revenues and the political situation.

Litigation

Product liability, regulatory or other significant cases may be lost or compromised resulting in a material loss or other consequence. Legal costs may increase significantly.

Time frame

Long term

Strategic impact

Growth

Considered in viability statement

Yes

Impact

Damages and fines, negative impact on reputation, disruption and loss of focus on the business.

Consolidated results of operations, cash flows and financial position could be materially affected, in a particular fiscal quarter or fiscal year, by an unfavourable outcome or settlement of pending or future litigation.

Mitigation activities

Consistent litigation strategy across the Group.

Expertise and legal talent maintained both within the Group and with our external partners.

Closer integration in Group litigation strategy and cost controls pursued.

Ongoing monitoring of key legislative, case law and tobacco developments.

Geopolitical tensions

Geopolitical tensions, social unrest, terrorism and organised crime have the potential to disrupt the Group's business in multiple markets.

Time frame

Medium term

Strategic impact

Growth

Considered in viability statement

Yes

Impact

Potential loss of life, loss of assets and disruption to normal business processes.

Increased costs due to more complex supply chain arrangements and/or the cost of building new facilities or maintaining inefficient facilities.

Mitigation activities

Globally integrated sourcing strategy and contingency sourcing arrangements.

Security risk modelling, including external risk assessments and the monitoring of geopolitical and economic policy developments worldwide.

Insurance cover and business continuity planning, including scenario planning and testing and risk awareness training.

Security controls for field force, direct store sales and supply chain with an emphasis on the protection of Group employees.

Inability to obtain price increases and impact of increases on consumer affordability thresholds

Annual manufacturers' price increases are among the key drivers in increasing market profitability. The Group faces a risk that such price increases will not materialise.

Time frame

Short/Medium term

Strategic impact

Growth

Considered in viability statement

Yes

Impact

Inability to achieve strategic growth metrics.

Funds to invest in growth opportunities are reduced.

Volumes may reduce faster than anticipated due to accelerated market decline leading to growth of illicit trade.

Mitigation activities

Key market and pricing reviews at Management Board meetings.

Pricing strategies, excise and trade margin committees exist in all markets with regional and global support.

Robust business cases underpinning key innovative launches.

Clear portfolio and pricing strategies, ensuring a balanced portfolio of strong brands across key segments.

Disputed taxes, interest and penalties

The Group may face significant financial penalties, including the payment of interest, in the event of an unfavourable ruling by a tax authority in a disputed area.

Time frame

Short /Medium term

Strategic impact

Productivity

Considered in viability statement

Yes

Impact

Significant fines and potential legal penalties.

Disruption and loss of focus on the business due to diversion of management time.

Impact on profit and dividend.

Mitigation activities

End-market tax committees.

Internal tax function provides dedicated advice and guidance, and external advice sought where needed.

Engagement with tax authorities at Group, regional and individual market level.

Market size reduction and consumer down-trading

The Group is faced with steep excise-led price increases and the continuing difficult economic and regulatory environment in many countries, market contraction and consumer down-trading is a risk.

Time frame

Short/Medium term

Strategic impact

Growth

Considered in viability statement

Yes

Impact

Volume decline and portfolio mix erosion.

Funds to invest in growth opportunities are reduced.

Mitigation activities

Geographic spread mitigates impact at Group level.

Clear monitoring of portfolio and pricing strategies, ensuring balanced portfolio of strong brands across key segments.

Increased focus behind product quality and innovation across all segments to provide tangible differentiation and improve the price-value ratio.

Overlap with many mitigation activities undertaken for other principal risks facing the Group, such as competition from illicit tobacco trade, significant excise increases or structure changes and inability to obtain price increases.

Foreign exchange rate exposures

The Group faces translational and transactional foreign exchange (FX) rate exposures for earnings/cash flows from its global business.

Time frame

Short /Medium term

Strategic impact

Productivity

Considered in viability statement

Yes

Impact

Fluctuations in FX rates of key currencies against sterling introduce volatility in reported EPS, cash flow and the balance sheet driven by translation into sterling of our financial results.

The dividend may be impacted if the payout ratio is not adjusted.

Differences in translation between earnings and net debt may affect key ratios used by credit rating agencies.

Volatility and/or increased costs in our business, due to transactional FX, may adversely impact financial performance.

Mitigation activities

While translational FX exposure is not hedged, its impact is identified in results presentations and financial disclosures; earnings are re-stated at constant rates for comparability.

Debt and interest are matched to assets and cash flows to mitigate volatility where possible and economic to do so.

Hedging strategy for transactional FX and framework is defined in the treasury policy, a global policy approved by the Board.

Illiquid currencies of many markets where hedging is either not possible or uneconomic are reviewed on a regular basis.

Injury, illness or death in the workplace

The risk of injury, death or ill health to employees and those who work with the business is a fundamental concern of the Group and can have a significant effect on its operations.

Time frame

Short term

Strategic impact

Sustainability

Considered in viability statement

Impact

Serious injuries, ill health, disability or loss of life suffered by employees and the people who work with the Group.

Exposure to civil and criminal liability and the risk of prosecution from enforcement bodies and the cost of associated fines and/or penalties.

Interruption of Group operations if issues are not addressed immediately.

High staff turnover or difficulty recruiting employees if perceived to have a poor Environment, Health and Safety (EHS) record.

Mitigation activities

Risk control systems in place to ensure equipment and infrastructure are provided and maintained.

An EHS strategy ensures that employees at all levels receive appropriate EHS training and information.

Behavioural-based safety programme to drive Operations' safety performance and culture closer to zero accidents.

Analysis of incidents undertaken regionally and globally to identify increasing incident trends or high potential risks that require coordinated action.

Solvency and liquidity

Liquidity (access to cash and sources of finance) is essential to maintaining the Group as a going concern in the short term (liquidity) and medium term (solvency).

Time frame

Short/Medium term

Strategic impact

Productivity

Considered in viability statement

Yes

Impact

Inability to fund the business under our current capital structure resulting in missed strategic opportunities or inability to respond to threats.

Decline in our creditworthiness and increased funding costs for the Group.

Requirement to issue equity or seek new sources of capital.

Reputational risk of failure to manage the financial risk profile of the business, resulting in an erosion of shareholder value reflected in an underperforming share price.

Mitigation activities

Group policies include a set of financing principles and key performance indicators including the monitoring of credit ratings, interest cover, solvency and liquidity with regular reporting to the Board.

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.

The Group, through B.A.T. International Finance p.l.c., holds a central banking facility of £3 billion with a final maturity of May 2021 spread across a wide banking group.

Liquidity pooling structures are in place to ensure that there is maximum mobilisation of cash liquidity within the Group.

The Group has an externally imposed capital requirement for its centrally managed banking facilities of maintaining gross interest cover above 4.5 times. The Group targets a gross interest cover of greater than 5.

Going concern and viability support papers are presented to the Board on a regular basis.

APPENDIX B

RELATED PARTY DISCLOSURES

The Group has a number of transactions and relationships with related parties, as defined in IAS 24 Related Party Disclosures, all of which are undertaken in the normal course of business. Transactions with CTBAT International Limited are not included in these disclosures as it is a joint operation.

As explained in note 30 [on the Notes on the Accounts to the Annual Report], the Group announced the proposed merger with Reynolds American on 17 January 2017.

Transactions and balances with associates relate mainly to the sale and purchase of cigarettes and tobacco leaf. Amounts receivable from associates in respect of dividends included in the table below were £221 million (2015: £145 million). The Group's share of dividends from associates, included in other net income in the table below, was £1,024 million (2015: £640million).

	2016 £m	2015 £m
Transactions
-revenue	370	38
-purchases	(298)	(270)
-other net income	1,023	639
Amounts receivable at 31 December	270	190
Amounts payable at 31 December	(2)	(20)

On 17 December 2012, a wholly-owned subsidiary of the Group, BATUS Japan Inc. (BATUSJ), entered into an Amendment and Extension Agreement (referred to as the Amendment) with a wholly-owned subsidiary of Reynolds American, R.J. Reynolds Tobacco Company (referred to as RJRTC). The Amendment modifies the American blend Cigarette Manufacturing Agreement (referred to as the 2010 Agreement), effective as of 1 January 2010.

Prior to the Amendment, the term of the 2010 Agreement was scheduled to expire on 31 December 2014, subject to early termination and extension provisions. Pursuant to the Amendment, the Manufacturing Agreement would remain in effect beyond 31 December 2014, provided that either RJRTC or BATUSJ may terminate the Manufacturing Agreement by furnishing three years' notice to the other party, such notice was given in January 2016. As a result of early termination of this agreement the Group agreed to a compensation payment of US$90 million of which US$7 million was paid to RJRTC on 22 September 2016, with the Group recognising the full expense of US$90 million as required by IFRS in 2016. The balance is due in March 2017.

During 2016, the Group received proceeds of £23 million in respect of its participation in the share buy-back programme conducted by Reynolds American. This programme ceased in the fourth quarter of 2016.

During 2016, the Group acquired the remaining 1% interest in Souza Cruz at a cost of £70 million. This transaction is shown as a £4 million increase in reserves attributable to the owners of the parent and a £4 million reduction in reserves attributable to non-controlling interests in note 19 [on the Notes on the Accounts to the Annual Report].

For comparative purposes, prior year's acquisitions are disclosed in note 24 [on the Notes on the Accounts to the Annual Report].

As explained in note 12 [on the Notes on the Accounts to the Annual Report], contributions to the British American Tobacco UK Pension Fund are secured by a charge over the Group's Head Office (Globe House) up to a maximum of £150 million.

The key management personnel of British American Tobacco consist of the members of the Board of Directors of British American Tobacco p.l.c. and the members of the Management Board. No such person had any material interest during the year in a contract of significance (other than a service contract) with the Company or any subsidiary company. The term key management personnel in this context includes the respective members of their households.

	2016 £m	2015 £m
The total compensation for key management personnel, including Directors, was:
-salaries and other short-term employee benefits	18	20
-post-employment benefits	3	4
-share-based payments	12	11
	33	35