Can new regulations ever reduce the profitability of tobacco companies?
Big Tobacco has earned its moniker; four tobacco companies control 75% of the world's cigarette market. The only exception is China: the world's largest cigarette market is controlled by the state-owned China National Tobacco Company.
British American Tobacco (LSE: BATS) is the world's number two tobacco company and the UK's largest, with a market value more than twice that of Imperial Tobacco (LSE: IMT).
In 2011, BAT sold 705 billion cigarettes globally, a 0.4% reduction on 2010. Despite this, it managed to improve operating margins by more than 2 percentage points to an enviable 35.8%.
BAT's operating profits rose by 9% in 2011, from £4,318m to £4,721m. Revenue rose by just 3%, highlighting the company's firm grip on costs.
Diluted earnings per share rose by 11%, a result which was reflected directly in an 11% dividend increase. This takes the total dividend for 2011 to 126.5p, a 4% yield at current prices.
BAT shares have long been a favourite with income seekers and 2011's results will do nothing to change this -- especially as BAT Chairman Richard Burrows reiterated the company's policy of paying out 65% of earnings as dividends.
As a large tobacco company, BAT naturally feels that governments around the world are conspiring against it. One common complaint from the company is about the negative effects of excise duty increases and the encouraging effect these have on smuggling activity.
While the link between high excise rates and smuggling is well proven, BAT's latest battle -- against plain packaging -- is less clear cut. Australia is planning to introduce mandatory plain packaging for cigarettes this year, in an effort to reduce smoking rates.
All four big tobacco companies have launched legal challenges against the Australian plain packaging rules, which are due to come into effect in December 2012.
BAT is due in court in April to contest the plain packaging rules. It will allege that preventing it from using its logos equates to trademark theft; if BAT is successful, other governments considering plain packaging rules might abandon the idea.
Safer than smoking
Investing in BAT is a much safer bet than consuming its products. It has near-perfect diversification across its global markets and its large size and cash generative nature means that it can cope with any short-term problems.
BAT's forward earnings should also be boosted by a massive £1.25bn share buyback programme which was confirmed by BAT in its results.
If you're looking for a stable, blue chip income share and are not ethically opposed to its business, BAT should definitely be on your short list.
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