Right now, I’m analysing some of the most popular companies in the FTSE 100 to establish if they are attractive long-term buy and forget investments.
Today I’m looking at British American Tobacco (LSE: BATS) (NYSE: BTI.US)
What is the sustainable competitive advantage?
British American is the second biggest publicly traded tobacco company in the world behind Marlboro maker, Philip Morris. Indeed, it is estimated that British American has a 15% share of the global tobacco market, giving the company a strong competitive advantage over its peers.
In addition, thanks to the company’s size and the addictive nature of tobacco, British American has the power to price its products how it sees fit. This allows the company to maintain its strong gross profit margin of around 78% by raising prices to offset declining cigarette sales.
For example, during the first half of this year the company’s volume of tobacco sold fell 3.4%, while profit expanded 4.9%.
Company’s long-term outlook?
Unfortunately, while British American’s near-term outlook seems healthy, as the company’s profits continue to grow, over the long-term the firm’s outlook is cloudy.
You see, the company cannot continue to raise prices indefinitely and sooner or later the company’s revenue and profit will start to decline, in line with the falling number of cigarettes shipped.
This puts a lid on the company’s long-term growth.
Still, the company is trying to diversify, recently launching the e-cigarette brand Vype in the UK as an alternative to traditional cigarettes. That said, although British American intends to sell Vype around the world, the global e-cig market is only currently worth $2 billion and the sector is highly competitive. So, growth from this division is unlikely to offset declining cigarette sales.
However, there is still a huge potential market available to British American in China. Currently, the Chinese tobacco market is monopolised by the state tobacco company, but if the government releases its control over the industry, then British American will be able to profit from China’s 350-400 million smokers.
Foolish summary
All in all, I feel that over the long-term, British American has a very restricted future. While the company is still growing at present, the firm cannot continue to raise prices indefinitely to offset falling cigarette sales.
Moreover, the global e-cigarette market is currently not big enough to take the place of the company’s annual cigarette sales, which will eventually disappear.
Having said that, the company still looks strong and investors should continue to reap rewards for some years to come.
So overall, I rate British American Tobacco as an average share to buy and forget.
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In the meantime, please stay tuned for my next FTSE 100 verdict
> Rupert does not own any share mentioned in this article.
