The shares of FTSE 100 tobacco titan British American Tobacco (LSE: BATS) (NYSE: BTI.US), currently trading at around 3,500p, have soared 100% over the last five years, more than double the 57% gain for the index.
However, the story could change over the next five years, as BAT’s shares have the potential to advance by a slower-burning 32%.
Here’s how
As the owner of a collection of strong brands, including Pall Mall, Lucky Strike and Rothmans, and as the world’s most international tobacco company, BAT is well placed to benefit from rising consumer prosperity in emerging markets.
However, tobacco companies are struggling to grow in the West, where increasing health education is taking its toll, and new headwinds, such as plain packaging, are only likely to add to tobacco companies’ difficulties. In the long term, as emerging markets emerge, it seems probable that they too will go down the route of raising health awareness and introducing policies and legislation that will make it tougher for the tobacco firms.
As it is, BAT and its rivals, also have near-term cyclical headwinds, such as weakness in cash-strapped southern Europe and adverse currency movements. Indeed, City experts are expecting to see a small decline in BAT’s earnings per share (EPS) this year. And, thereafter, slower annual earnings growth than the double-digit rises shareholders had enjoyed for many years.
The consensus earnings forecasts give a five-year compound annual growth rate (CAGR) of 5.6%, taking EPS from last year’s 217.4p up to about 286p — a total increase of 32%.
BAT’s current trailing price-to-earnings (P/E) ratio is just a tad below the FTSE 100’s long-term average of 16. So, if the shares track earnings, and continue to rate at their current P/E, the price will rise by the same 32% as EPS, putting BAT’s shares at about 4,540p five years from now.
Companies in defensive industries — those whose products or services are relatively resilient in most economic conditions — tend to trade on premium P/Es. Alcoholic drinks giant Diageo, for example, currently trades on a P/E of 17.5.
In the case of BAT, it seems that in the eyes of the market, the company’s defensive qualities are undermined by the headwinds facing the tobacco industry. Hence, we have an average, rather than premium P/E.
The flip side is that BAT’s dividend yield is higher than it would otherwise be, and investors can expect a decent return from income on top of the potential 32% share price rise over the next five years. The trailing yield is an above-average 4.1%, and with a forecast dividend CAGR of 5.5%, about in line with earnings, we’d see a total of 835p a share paid out over the period. Put another way, a £1,000 investment in BAT today would deliver £242 in dividends alone.
