Which Is Your Best Defensive Bet: British American Tobacco plc, SSE PLC Or Dignity Plc?

British American Tobacco plc (LON:BATS), SSE PLC (LON:SSE) and Dignity Plc (LON:DTY) are under the spotlight after news today.

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

British American Tobacco (LSE: BATS), utility SSE (LSE: SSE) and funerals group Dignity (LSE: DTY) all released news this morning, prompting their shares to move higher when the markets opened.

British American Tobacco (BAT) reported continuing headwinds from declining cigarette volumes and currency exchange rates. The first half of the year saw volumes decline 2.9%. Revenue declined 5.9%, but would have risen 2.4% if exchange rates had remained constant. Similarly, earnings per share (EPS) fell 1.6%, but would have been up 3.9% at constant exchange rates. The Board lifted the interim dividend by 4%, being “confident that we are on course to deliver an improved second half”.

Dignity also released first-half results. Revenue rose 19.2% and EPS soared 58.5%, the strong performance being principally as a result of a 13.2% increase in the number of deaths compared with the same period last year. The Board increased the interim dividend by 10%, and said it now anticipates that full-year results will be ahead of its previous expectations. However, it also cautioned that “expectations for 2016 and beyond remain positive but unchanged as there is a strong possibility that the number of deaths in 2016 may be significantly lower following the very high number of deaths in 2015”.

SSE’s news wasn’t a results release, but was a reminder that utilities need to make ongoing substantial capital investment: the company has agreed to acquire gas assets for £565m, with an additional forecast investment of £350m needed to complete the development.

BATS, Dignity and SSE are solid defensive businesses — that’s to say, businesses that aren’t too badly affected by the ups and downs of the economy — and provide a good foundation for a portfolio. But, of course, we have to consider their track records, future prospects and current valuations in deciding whether they make for a good investment at the present time.

The table below shows the earnings-per-share (EPS) growth rate of the three companies for the last five years, and forecasts for the next two years.

  2010 2011 2012 2013 2014 2015 forecast 2016 forecast
BATS 15 11 5 5 -4 0 8
SSE* 2 0 5 4 1 -10 6
Dignity 15 19 14 15 19 15 12

* BATS and Dignity have December year ends. SSE has a March year end. In the 2010 column SSE’s figure is for March 2011, in the 2011 column for March 2012, and so on.

As you can see, BAT’s earnings growth has slowed markedly in recent times, turning negative last year. However, there is an improving outlook, and positives include scope for some further consolidation in the tobacco industry, the ability to raise prices in emerging markets as disposable income in those territories increases, and next-generation products, such as e-cigarettes. BAT’s growth in the next 20 years may not be as high as it’s been in the past, but the 8% EPS increase forecast for 2016 could be a sustainable rate.

Governments don’t want vital utilities to make too much profit for shareholders at the expense of consumers, so SSE’s earnings growth is never going to be as high as that of a successful company operating in the free market. This year’s forecast earnings dip is unusual, but as you can see from the table, growth isn’t scintillating at the best of times. Increases in EPS somewhat ahead of inflation (next year’s forecast 6%, for example) is the long-term prospect for regulated utilities, with lower risk being the compensation for the relatively modest growth.

Dignity owns and operates crematoria and funeral parlours. The latter is a highly fragmented industry, with many single, often family-run businesses and small chains. Dignity is a consolidator, and as it’s scale is growing, such businesses are being attracted by the investment, lower costs and so on that being part of a larger group can bring. As you can see, Dignity has been consistently increasing earnings at a faster rate than both BAT and SSE. Furthermore, the company can continue growing at a strong rate, because it still has huge scope to increase its market share.

What of valuations? How much is the market asking us to pay for these three companies with their rather different rates of earnings growth?

SSE trades on a forward price-to-earnings (P/E) ratio of 13.5, and I’d suggest mid-single digits is a sustainable earnings growth rate. BAT’s P/E is 17.5, with potentially high single-digit growth. Dignity’s P/E is 24, with mid-teens growth appearing realistic.

All three companies deliver substantial amounts of cash to shareholders: SSE’s forward dividend yield is currently 6% and BAT’s is 4.3%. Dignity’s yield is 1%, but the company makes substantial capital returns to shareholders from time to time, making it a higher yielding stock than the ordinary dividend might suggest.

All three companies appear to me to be reasonable value at the present time, with SSE being the obvious choice for those seeking an immediate high income.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

G A Chester has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Investing Articles

Are these the best stocks to buy on the FTSE right now?

With the UK stock market on the way to hitting new highs, this Fool is considering which are the best…

Read more »

Petrochemical engineer working at night with digital tablet inside oil and gas refinery plant
Investing Articles

Can the Centrica dividend keep on growing?

Christopher Ruane considers some positive factors that might see continued growth in the Centrica dividend -- as well as some…

Read more »

Smiling family of four enjoying breakfast at sunrise while camping
Investing Articles

How I’d turn my £12,000 of savings into passive income of £1,275 a month

This Fool is considering a strategy that he believes can help him achieve a stable passive income stream with a…

Read more »

Person holding magnifying glass over important document, reading the small print
Investing Articles

2 top FTSE 250 investment trusts trading at attractive discounts!

This pair of discounted FTSE 250 trusts appear to be on sale right now. Here's why I'd scoop up their…

Read more »

Smiling young man sitting in cafe and checking messages, with his laptop in front of him.
Investing Articles

3 things that could push the Lloyds share price to 60p and beyond

The Lloyds share price has broken through 50p. Next step 60p? And then what? Here are some thoughts on what…

Read more »

Young female business analyst looking at a graph chart while working from home
Investing Articles

£1,000 in Rolls-Royce shares a year ago would be worth this much now

Rolls-Royce shares have posted one of the best stock market gains of the past 12 months. But what might the…

Read more »

Investing Articles

Are HSBC shares a FTSE bargain? Here’s what the charts say!

There are plenty of dirt-cheap FTSE 100 banking stocks for investors to choose from today. Our writer Royston Wild believes…

Read more »

Three signposts pointing in different directions, with 'Buy' 'Sell' and 'Hold' on
Investing Articles

Just released: Share Advisor’s latest ‘Hold’ recommendation [PREMIUM PICKS]

In our Share Advisor newsletter service, we provide buy, sell, and hold guidance for our universe of recommendations.

Read more »