Price Rises Present A Golden Opportunity For British American Tobacco Plc

The scope for increases in the prices of its cigarettes across the globe presents British American Tobacco plc (LON: BATS) with a superb opportunity.

Peter Stephens

Having held various senior management positions in the manufacturing sector, Peter founded his own manufacturing company in 1996. This was subsequently sold in 2007. Meanwhile, his passion for investing (which began during the privatisations of the 1980s) remains strong and he couples this with writing for The Motley Fool as a Contractor. His investment style is value-oriented; focusing on company fundamentals, as well as assessing the strength and presence of a competitive advantage. While above-average growth prospects remain very attractive, a greater focus on dividends has crept in since Peter became a part-time retiree in 2007.

Published 2 August, 2013 1:42 pm BST

| More on: BATS

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.

In the UK, we consider the price of a packet of cigarettes to be exceptionally high. Indeed, non-smokers such as myself find it difficult to appreciate how companies such as British American Tobacco (LSE: BATS) (NYSE: BTI.US) can get away with charging in excess of £8.50 for 20 cigarettes.

Certainly, the price of cigarettes versus the median income in the UK is high and makes smoking a very expensive habit. However, we in the UK seem to be in the minority, since the cost of smoking compared to median incomes in other countries across the globe is not so high. This means that tobacco companies such as BAT are able to increase prices so as to improve margins.

Furthermore, price rises are not limited to countries where smoking is relatively less expensive than in the UK. Ten years ago, a packet of cigarettes in the UK cost roughly half what it does today and this trend seems to be continuing, with tobacco companies squeezing yet higher prices out of UK smokers. Of course, doing so is a no-brainer, as the proportion of UK adults who smoke has remained at or near to 20% for the last handful of years.

So, despite the volume of cigarettes sold across the world continuing to decline, BAT is able to increase turnover via higher prices. Interestingly, the company’s recent interim results showed that volumes fell by 2% and yet turnover increased by 4%.

In addition, BAT offers very stable earnings growth prospects and, although earnings are not as reliable as that of a utility, they are probably not too far away. Analysts expect earnings per share to grow at just under 8% per annum over the next two years and, based on past performance, it is likely that this expectation will be met.

In addition to having bright future prospects, BAT currently yields an attractive 3.9% and, although it trades on a price-to-earnings (P/E) ratio of 16.9, this is still less than its industry group (consumer goods), which has a P/E of 17.3.

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> Peter does not own shares in British American Tobacco.