The current investment case for British American Tobacco (LSE: BATS) (NYSE: BTI.US) is a little confusing. On the one hand, it has all the hallmarks of a great income stock.
On the other hand, I believe the tobacco industry is in decline, and BAT’s total sales have been falling for a number of years.
BAT’s shares aren’t cheap, either, and the firm has plenty of debt. So is BAT a buy, or a sell?
1. +23%
BAT shares have risen by 23% since 5 February, completing a remarkable rebound that has left the firm’s performance in-line with that of the FTSE 100 over the last year, up by around 2%.
However, February’s slide provided investors with a genuinely good opportunity to top up on BAT — at the shares’ lows, they offered a prospective yield of 5% and a 2014 forecast P/E of just 13.5, compared to today’s less compelling values of 4.1% and 16.6.
2. £250m
Last week, BAT confirmed it is involved in the complex takeover discussions between US firms Reynolds American, in which BAT has a 42% shareholding, and Lorillard.
In an article earlier this year, I suggested that BAT’s share of Reynolds’ profits could rise by around £250m per year, if the deal proceeds as it’s expected to, with Lorillard’s main brand, Newport, being absorbed into the Reynolds portfolio.
However, these extra profits won’t come cheap — BAT is expected to fund part of the Reynolds-Lorillard deal by purchasing new shares in Reynolds, which may require BAT to add to its £11.7bn debt pile.
3. -6.6%
In 2009, BAT reported group sales of 724bn cigarettes, or ‘stick equivalents’.
By the end of 2013, that total had fallen by 6.6% to 676bn. It’s a trend that’s expected to continue — BAT’s group sales fell by 1% during the first quarter of this year, despite volumes at its core brands rising by 6.3%.
The twist is that BAT’s increasing profitability and large share buybacks have meant that earnings per share — and the firm’s dividend — have continued to rise, regardless of falling sales, rewarding shareholders’ loyalty.
Can this balancing act continue? Rising debt costs could put pressure on the situation, as could a more rapid decline in sales.
However, I suspect BAT will continue to reward investors with an above-average dividend yield for some time to come, thanks to its global scale and profitability.
