MARKET COMMENT
Light Up Your Portfolio

By David Kuo (TMFDragon)
March 10, 2004

Smoking is one of the leading causes of statistics - Anon

Despite the overwhelming evidence that points to the many dangers of smoking, and the numerous anti-smoking programmes organised by health authorities around the world (No Smoking Day today in the UK for example), smoking is still on the rise.

The simple reason is because world population is growing faster than the rate at which smokers are giving up the nicotine habit. It is estimated that by 2050, there could be 1.34b smokers worldwide compared to 1.28b today. (Global population is expected to grow from 6 billion to 9 billion.)

Whilst that points to a fall in the proportion of smokers, from around 21% today to 15% in fifty years' time, the absolute numbers are increasing. Consequently, cigarette companies and businesses related to the tobacco industry should continue to see stable if not slightly increasing demand.

In the UK, British American Tobacco (LSE: BATS) is by far the largest cigarette firm with a market value of £16.9b. The company has a strong presence in many cigarette-friendly, non-European countries, and this accounts for 82% of its total turnover.

Revenue over the last three years has remained steady at £11b and operating margins have been reasonably steadfast at 24%. Cash flow continues to be strong allowing the company to pay a generous proportion of its profits in dividends. BAT is expected to post a pre-tax profit of £2.6b this year. Forecast earnings per share of 74p value the company at 11 times earnings. Its divided yield is a market-beating 5.3% at the current share price of 815p.

Imperial Tobacco (LSE: IMT) is Britain's No.2 cigarette maker. Unlike BAT, Imperial Tobacco is heavily dependent on Europe, which accounts for 83% of total sales. The UK alone accounts for almost 70% of its revenues. Two years ago, Imperial Tobacco bought the German tobacco firm Reemtsma, which almost doubled its size. However, the acquisition also boosted its debt, to an eye-popping £3.7b.

Despite the increased interest payments on those loans, cash flow was still a healthy 36% of operating profit last year. Earnings per share of 100p have been pencilled in for 2004, which values the company at 12 times earnings. The dividend yield at 4.1%, whilst lower than BAT's, is still quite generous. Imperial Tobacco shares stand at 1,184p.

The UK's No.3 cigarette maker is Gallaher (LSE: GLH). The company has been hugely acquisitive over the last couple of years, buying Russia's Liggett-Ducat and Austria's Tabak. It also signed an agreement with China's National Tobacco Corp., which would allow its brands to be openly distributed in China. At 682p, the shares are valued at 11 times prospective earnings, and the dividend yield is 4.7%.

Bunzl (LSE: BNZL) is an interesting lateral play on the cigarette market. The company, better known as a supplier of disposable supplies to supermarkets, also makes cigarette filters at its Filtrona division. With earnings per share of 32p chalked up for this year, Bunzl is valued at 15 times earnings.

Other peripheral players in the cigarette market include Molins (LSE: MLIN) and Dickinson Legg (LSE: DKL). Both companies manufacture machines that are used in the processing of tobacco. Molins is valued at 8 times forecast earnings and Dickinson Legg is more expensive at 12 times prospective profits. Both companies have warned of difficult trading in recent weeks however.

As an ex-smoker, albeit of just 24 hours, I reckon it is about time that I start to claw back some of the money that I have paid out to the cigarette makers for far too many years. And what better way than to invest my cigarette money in one of the high-yielding tobacco companies. It may not ease the short-term pain of giving up smoking but the generous dividend yields should make me a bit wealthier over the long-term!