MENU

Should I Buy British American Tobacco plc?

Still smokin’?

Last time I looked at British American Tobacco (LSE: BATS) (NYSE: BTI.US), I said it was a buy but a challenging one. Smoking is a long-term decline in the West. The rules surrounding cancer sticks will only tighten (soon, even prisoners could be banned from lighting up). Anti-smoking campaigns trends will surely spread to emerging markets, hitting recent sales growth. Can BAT still light up your portfolio?

Despite these challenges, BAT’s share price has grown 85% over the past five years and 40% over three. But recent performance hasn’t been so addictive, BAT grew just 4% in the last year, against 12% for the FTSE 100 as a whole. That’s despite a steady first half, with group revenue up 4% and adjusted group profit up 6% at constant rates of exchange.

The impressive thing is that BAT’s results came despite a 3.4% drop in group cigarette volumes to 332 billion, thanks to good pricing momentum and growing market share. Impressive, but also worrying. I generally don’t like businesses in shrinking markets, although at least BAT exhales cash, with first-half profit of £2.8 billion, up 3% on last year.

Imperious tobacco

For many investors, BAT is all about the dividend. Right now, it yields 4%, covered 1.5 times, beating the FTSE 100 average of 3.5%. But that is less than Imperial Tobacco Group (LSE: IMT) (NASDAQOTH: ITYBY.US), which currently yields a tastier 4.59%, covered 1.9 times. BAT’s board has a progressive dividend policy, recently declaring an interim dividend of 45p, a 7% increase on last year, to be paid on 30 September 2013. Steady earnings per share (EPS) growth of 6% this year and 8% in 2014 could take that yield to a healthy 4.6%. Again, not to be sniffed at.

Trading at 16.1 times earnings, against 15.1 for the index as a whole, BAT isn’t that cheap. Imperial Tobacco is notably cheaper at 11.5 times earnings. Is BAT really worth the price? It has done well to maintain its revenues and profits, but the challenges are lining up: tobacco taxes will continue their inexorable rise (making it harder for companies to raise prices to offset shrinking margins), the illicit tobacco trade is growing, changes to packaging could choke key brands, litigation is a constant threat.

BAT is innovating, recently becoming the first tobacco giant to launch an electronic cigarette in the UK, in July, with its Vype product, which has had mixed reviews. Frankly, e-cigarettes strike me as a bit daft, but I’m no smoker, so what do I know? Citigroup and Bank of America both have BAT as a buy, with target prices of £38 and £40 respectively. Today, you can buy it for £33.74.

BAT is still a buy for me, but you can get a higher income from Motley Fool's favourite stock pick. Our analysts have singled out this FTSE 100 favourite because it offers a sky-high yield and great growth prospects. To find out what it is, download our free guide Power up Your Portfolio. It won't be available much longer, so click here now.

> Harvey doesn't own shares in any company mentioned in this article