FTSE-beating growth and large dividends make tobacco shares ideal for retirement.
Identifying shares that can be safely stashed away in your pension and left to deliver the goods for twenty years isn't easy, but I have a couple of suggestions.
British American Tobacco (LSE: BATS) and Imperial Tobacco (LSE: IMT) are the second- and fourth-largest tobacco companies in the world. Between them, they sold 1.1 trillion cigarettes last year to smokers all over the world.
Ethical investors may baulk at tobacco's undoubted health risks, but purely from an investing point of view, these two companies make good sense.
So here are five reasons to consider putting tobacco shares in your pension portfolio:
1. Reassuringly large
Both BAT and Imperial are large FTSE 100 (UKX) companies, with more than 100 years of successful trading behind them. They should be fairly safe homes for your cash over long periods of time.
Here's a quick look at the essential statistics of each company:
| Company | British American Tobacco | Imperial Tobacco |
|---|
| Market Cap | £65bn | £24bn |
| 2011 Pre-Tax Profits | £4.9bn | £2.1bn |
| Price/Earnings Ratio | 16.8 | 12.8 |
| Dividend Yield | 3.9% | 4.0% |
| Cigarettes sold (2011) | 705 billion | 343 billion* |
| Key brands | Lucky Strike, Dunhill, Pall Mall, Kent. | Davidoff, Gauloises Blondes, West, Lambert and Butler, JPS, Golden Virginia. |
*including cigarette equivalents such as cigars
2. Big Profits = Big Dividends
All of the big tobacco companies have spent many years working hard to consolidate and cut costs. This has been done mostly through acquisition, and the resulting economies of scale have created some very lean and efficient operations.
BAT enjoys especially impressive profit margins. During 2011 for instance, the firm delivered an operating margin of more than 35%. In addition, spare cash and a mature business mean plenty of dividend potential: BAT's dividend policy is to pay out an impressive 65% of earnings each year to shareholders.
Assuming that BAT manages to sustain earnings growth at or above the rate of inflation, shareholders should collect an inflation-beating dividend rise every year!
BAT's huge profit margins seem to be derived from its larger size and emerging market strength -- Imperial's operating margin was only 9.5% in 2011 and this figure has fallen steadily from 15.4% in 2008.
BAT and Imperial both currently offer dividend yields of around 4% -- above average for the FTSE 100 and an attractive yet sustainable level.
3. Wide 'moats'
'Economic moats' reflect a company's competitive advantage. Typically, they represent high barriers to entry that can produce above-average profits as potential competitors are stopped from completing on even terms.
The big tobacco companies all benefit from wide moats thanks to their large scale, multiple brands and addictive products.
Smokers do not tend to stop smoking when money is tight -- they are more likely to simply switch to a cheaper brand, which will quite often be made by the same company as their previous brand. Imperial Tobacco, for example, has a 45% share of the UK cigarette market.
4. Home and away
BAT was originally formed in 1902 as a joint venture between Imperial Tobacco and the American Tobacco Company. BAT's purpose was to develop the cigarette trade in emerging markets and this strategy has been highly successful -- today, BAT is more than twice the size of Imperial Tobacco.
BAT's global footprint is one of its key strengths, protecting it from regional downturns and giving it access to expanding emerging markets, where increasingly wealthy consumers are moving from cheap local names to fashionable global brands:
| Region | 2011 Profits (%) |
|---|
| Asia-Pacific | 27% |
| The Americas | 26% |
| EEMEA (Eastern Europe, Middle East & Africa) | 25% |
| Western Europe | 22% |
Source: BAT
By contrast, 65% of Imperial Tobacco profits came from EU countries in 2011, which is probably why Imperial Tobacco's growth has fallen behind that of BAT since 2009.
5. The choice of experts
My pick of these two shares would be BAT, but one man who really knows how to identify a long-term profitable business is Neil Woodford, one of the City's most successful fund managers. Tobacco shares make up 16% of the £20bn portfolio he manages for private investors such as you and me.
Mr Woodford's record is one of the best in the City -- between 1996 and 2011, his stock choices rose in value by up to 347% -- outperforming the 42% gain of the wider market by a huge margin. Returns like this can make a huge difference to the eventual size of your pension income.
The good news is that you can find why Neil Woodford bought BAT and Imperial -- as well as details about his other favourite holdings -- in this special free report. The Motley Fool's "8 Shares Held By Britain's Super Investor" is currently free to download and carries no obligation -- but hurry, as it is available only for a limited time.
Are you looking to profit from this uncertain economy? "10 Steps To Making A Million In The Market" is the very latest Motley Fool guide to help Britain invest. Better. We urge you to read the report today -- it's free.
Further investment opportunities:
> Roland does not own shares in any of the companies mentioned in this article.
